Liquidity biases in asset pricing tests

Elena Asparouhova, Hendrik Bessembinder, Ivalina Kalcheva

Research output: Contribution to journalArticlepeer-review

120 Scopus citations


Microstructure noise in security prices biases the results of empirical asset pricing specifications, particularly when security-level explanatory variables are cross-sectionally correlated with the amount of noise. We focus on tests of whether measures of illiquidity, which are likely to be correlated with the noise, are priced in the cross-section of stock returns, and show a significant upward bias in estimated return premiums for an array of illiquidity measures in Center for Research in Security Prices (CRSP) monthly return data. The upward bias is larger when illiquid securities are included in the sample, but persists even for NYSE/Amex stocks after decimalization. We introduce a methodological correction to eliminate the biases that simply involves weighted least squares (WLS) rather than ordinary least squares (OLS) estimation, and find evidence of smaller, but still significant, return premiums for illiquidity after implementing the correction.

Original languageEnglish (US)
Pages (from-to)215-237
Number of pages23
JournalJournal of Financial Economics
Issue number2
StatePublished - May 2010
Externally publishedYes


  • Asset pricing
  • Bias correction
  • G12
  • G19
  • Illiquidity
  • Microstructure noise
  • Return premium

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management


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