Is the Illiquidity Premium Really Gone?

The apparent weakness of the U.S. equity illiquidity premium is largely explained by hard-to-borrow stocks embedded in illiquid portfolios.

• Greg Leonard studies NYSE, Amex, and Nasdaq common stocks from July 1964 to March 2022, using Amihud illiquidity, equity loan fees, and monthly portfolios that buy the least liquid quintile and short the most liquid quintile.
• From July 2013 to March 2022, the all-stock illiquidity-minus-liquidity portfolio returned -0.32% per month before adjustment, while its FF5* alpha rose from 0.17% to 0.49% after excluding the highest-loan-fee stocks. The 0.33 percentage-point increase was statistically significant, with t = 3.53.
• Short-sale-constrained stocks represented 28% of the illiquid leg and fewer than 1% of the liquid leg. After excluding microcaps, the alpha improved from -0.18% to 0.10% per month, while the 0.28 percentage-point change remained statistically significant.
• Amihud illiquidity and loan fees had rank correlations of 0.47 across all stocks and 0.27 excluding microcaps. Among ex-microcap stocks, median annual fees were 1.05% for high-fee stocks and 0.56% for general-collateral stocks, reaching 7.97% at the 90th percentile.
• High borrowing costs were associated with stronger short-term reversal and greater price impact. A one-percentage-point rise in annualized loan fees was associated with increases of 0.197 in immediate impact and 0.155 in permanent impact after stock fixed effects and controls.

Takeaway: Investors should treat loan fees as a conditioning variable when evaluating illiquidity, reversal, and long-short strategies, while recognizing that the historical evidence before 2013 relies on indirect signals because comprehensive lending data are unavailable.