Can Liquidity be a Risk Factor that Predicts Economic Growth?: The U.S. and International Evidence

Abstract

We examine whether illiquidity premium, constructed as a difference in returns between the most illiquid and the least illiquid (or the most liquid) portfolios, predict future economic growth, measured by GDP growth rate. We find supporting evidence that the premium significantly predict future GDP growth rate in the U.S. even with various controls such as HML, SMB, dividend yield, industrial production, term premium, and default premium. Our empirical evidence provides new rational for why liquidity, a stock characteristic, is priced – since it has information about future real economy. However, contrast to the U.S. results, empirical evidence is mixed and generally weaker in the global sample of stocks from 35 countries.