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Amihud's (2002) stock (il)liquidity measure averages daily ratios of absolute close-to-close return to dollar volume, including overnight returns, while trading volumes come from regular hours. Our modified measure addresses this mismatch by using open-to-close returns. It is more strongly correlated with standard trading-cost measures (by 8-37%) and it better explains cross-sections of returns, doubling estimated liquidity premia. Using non-synchronous trading near close as an instrument reveals that overnight returns are primarily information-driven and orthogonal to price impacts of trading: including them in liquidity proxies magnifies measurement error, understating liquidity premia. Our modification helps wherever use of Amihud's measure is required. Our measures are publicly available to researchers for the years 1964-2019, and can be updated in future years using CRSP and COMPUSTAT. |
