Liquidity and the implied cost of equity capital

We investigate the impact of liquidity level and risks on the implied cost of equity capital for 14,808 stocks from 52 countries. We find that the implied cost of equity increases in the illiquidity level and in the co-variance between firm-level illiquidity and market illiquidity, but decreases both in the covariance between firm-level returns and market illiquidity and in the co-variance between firm-level illiquidity and market returns. Specifically, an increase from the 25th to the 75th percentile of the aggregate liquidity risk factor increases the cost of equity by 109 basis points. The evidence we report is robust to wide range of tests. We also observe that liquidity level and risks impact the implied cost of equity during crisis and no-crisis periods, but this relation is more pronounced during crisis periods for the most illiquid stocks. (C) 2017 Elsevier B.V. All rights reserved.