The impact of illiquidity risk for the Nordic markets

In this study, we propose a new measure of illiquidity for small, open stock markets; dollar zero-returns. Compared with other commonly used measures of illiquidity, the dollar zero-return produces the highest anomalous return across all four Nordic markets. In testing the pricing implication of the proxies of illiquidity, we use liquidity adjusted asset pricing models suggested in the literature for a panel of 25 size-related portfolios for the Nordic markets. Our results show that the only illiquidity measure that gives a significant positive effect across all Nordic markets is the dollar zero-return. Our results also show that the illiquidity mimicking portfolio factor, constructed through dollar zero-return, is the only factor showing a significant premium across different specifications, and its pricing remain significant also when the effect of the level of illiquidity (constructed through all measure of illiquidity) and of size is netted out.