Illiquidity and stock returns: the moderating role of investors' holding period in Central and Eastern European markets

Purpose - The positive illiquidity–return relationship (so-called liquidity premium) is a well-established pattern in international developed stock markets. The magnitude of liquidity premium should increase with market illiquidity. Existing studies, however, do not confirm this conjecture with regard to frontier markets. This may result from applying different approaches to the investors' holding period. The paper aims to identify the role of the holding period in shaping the illiquidity–return relationship in emerging and frontier stock markets, which are arguably considered illiquid. Design/methodology/approach - The authors utilise the data on stocks listed on fourteen exchanges in Central and Eastern Europe. The authors regress stock returns on liquidity measures variously transformed to reflect the clientele effect in a liquidity–return relationship. Findings - The authors show that the investors' holding period moderates the illiquidity–return relationship in CEE markets and also show that the liquidity premium in these markets is statistically and economically relevant. Practical implications - The findings may be of great interest to investors, companies and regulators. Investors and companies should take liquidity into account when making decisions; regulators should employ liquidity-enhancing actions to decrease companies' cost of capital and expand firms' investment opportunities, which will improve growth perspectives for the entire economy. Originality/value - These findings enrich the understanding of the role that the investors' holding period plays in the illiquidity–return relationship in CEE markets. To the best knowledge, this is the first study which investigates the effect of holding period on liquidity premium in emerging and frontier markets.