MARKET MICROSTRUCTURE AND ASSET PRICING - ON THE COMPENSATION FOR ILLIQUIDITY IN STOCK RETURNS

Models of price formation in securities markets suggest that privately informed investors create significant illiquidity costs for uninforme d investors, implying that the required rates of return should be high er for securities that are relatively illiquid. We investigate the emp irical relation between monthly stock returns and measures of illiquit y obtained from intraday data. We find a significant relation between required rates of return and these measures after adjusting for the Fa ma and French risk factors, and also after accounting for the effects of the stock price level.