Liquidity Premium and Transaction Cost

Abstract

Low infrequent trading implies low liquidity. Liquidity and transaction cost are two sides of the coin. Whether transaction cost is the determinant of stock liquidity premium? This paper selects common stocks of NYSE/Amex/Arca/ Nasdaq from 1926 to 2011 as research samples, makes a comprehensive analysis through Fama-French three factor model and Fama-French five factor model, LCAPM model and Pástor Stambaugh model. The results show that the ability of BA12, LOT12, CS12, and Cgibbs is limited, which means that transaction cost is not the determinant of liquidity premium, and the influence of transaction cost on the expected return of stock is indirect and secondary. The research provides a strong empirical experience for the asset pricing power of transaction cost is the second order. Thus, from the perspective of pricing meaning, transaction cost is not the decisive factor of price.