tradingTreasurybondsorbills.Itfollowsthereforethatsome
oftheriskpremiumattributedtoequityhastoreflectthese
additional transactions costs. Jones (2002), for instance,
examinesbid-askspreadsandtransactionscostsfortheDow
Jones stocks from 1900 to 2000 and concludes that the
transactionscostsareabout 1 percentlowertodaythanthey
were in theearly1990sand that thismay accountfor the
lower equity risk premium in recent years.
40 Healso presents evidence thatincreases in thebid-ask
spread and lower turnover are harbingers of higher stock
returns in the future, which he takes as evidence that
illiquidity is a factor behind both the magnitude of and
changesintheequityriskpremiums.Hisresearchisinline
with that of others who have argued that variations in
liquidity(andtheassociatedcosts)overtimemayexplaina
portionoftheshiftsintheequityriskpremiumfromperiodto
period.
Cross-Sectional Differences
Some stocksaremoreliquid thanothers,and studies have
lookedattheconsequencesofthesedifferences inliquidity
for returns. The consensus conclusion is that investors
demandhigherreturnswheninvestinginmoreilliquidstocks.
Putanotherway,investorsarewillingtopayhigherpricesfor
moreliquidinvestmentsrelativetolessliquidinvestments.In
our earlier discussion of adjusting discount rates for
illiquidity, we pointedto evidencethat some of thereturn
variation across stocks canbe explained by differences in
illiquidity.
There has been other research that seems to establish a
connection between stock price movements and liquidity.