The Liquidity Premium in Equity Pricing under a Continuous Auction System

Abstract

The paper shows that the cost of illiquidity is not (positively) priced over all months in the Spanish continuous auction system, where liquidity is provideh in the absence of market makers. Two distinct approaches are employed. Both the two-step traditional cross-sectional method and the pooled cross-section time series analysis tend to indicate that the liquidity premium is negative during months other than January. Morever, the liquidity premium in January is positive (although not significant) and at the 10% level it seems to be significantly higher than the liquidity premium over the rest of the year. Therefore, given the previous results for the US market, we conclude that, independently of the market trading mechanism with the exception of NASDAQ, the behaviour of the relationship between the bid-ask spread and stock returns is rather similar.