Illiquidity and Performance Attribution: A Primer

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Liquidity risk is the inability to trade assets at a fair price with immediacy. Although liquidity risk can deleteriously impact returns and, therefore, should be priced, it is not being adequately addressed by existing performance attribution models. Consequently, alphas are likely substantially misstated, especially so for highly illiquid securities and when market volatility is high. This primer provides a discussion of liquidity and its commonly used proxies, with the goal of stimulating research that could eventually yield a liquidity risk-based performance attribution
model.

Alexander Amati, Ph.D., Rutgers Business School and
Ben J. Sopranzetti, Ph.D., Rutgers Business School

Liquidity risk is the inability to trade assets at a fair price with immediacy. Although liquidity risk can deleteriously impact returns and, therefore, should be priced, it is not being adequately addressed by existing performance attribution models. Consequently, alphas are likely substantially misstated, especially so for highly illiquid securities and when market volatility is high. This primer provides a discussion of liquidity and its commonly used proxies, with the goal of stimulating research that could eventually yield a liquidity risk-based performance attribution
model.

Alexander Amati, Ph.D., Rutgers Business School and
Ben J. Sopranzetti, Ph.D., Rutgers Business School

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