This study examines how limits of arbitrage can affect the pricing of idiosyncratic volatility. Using both unique trading constraints in the Chinese stock market and other commonly-used limits-of-arbitrage measures, we construct a comprehensive limits-of-arbitrage index. Based on this index, we find that the negative idiosyncratic volatility return premium is much stronger and more persistent in stocks with high limits of arbitrage. Furthermore, the existing explanations about the idiosyncratic volatility return premium cannot fully explain what we find about the role of limits of arbitrage in the pricing of idiosyncratic volatility in the Chinese stock market. Our study suggests that the trading constraints introduced in the name of protecting individual investors can actually hurt them, since these additional limits of arbitrage will increase the inefficiency of the security market.

We examine the illiquidity premium in stock markets across 45 countries and present two findings. First, the average illiquidity return premium across countries is positive and significant, after controlling for other pricing factors. The premium is measured by monthly return series on illiquid-minus-liquid stocks or by the coefficient of stock illiquidity estimated from cross section Fama-MacBeth regressions. Second, a commonality exists across countries in the illiquidity return premium, controlling for common global return factors and variation in global illiquidity. This commonality is different from commonality in illiquidity itself and is greater in globally integrated markets.

Consistent with recent theoretical models where binding capital constraints lead to sudden liquidity dry‐ups, we find that negative market returns decrease stock liquidity, especially during times of tightness in the funding market. The asymmetric effect of changes in aggregate asset values on liquidity and commonality in liquidity cannot be fully explained by changes in demand for liquidity or volatility effects. We document interindustry spillover effects in liquidity, which are likely to arise from capital constraints in the market making sector. We also find economically significant returns to supplying liquidity following periods of large drops in market valuations.

This paper studies the dynamic interaction between the net positions of traders and risk premiums in commodity futures markets. Short‐term position changes are driven mainly by the liquidity demands of noncommercial traders, while long‐term variation is driven primarily by the hedging demands of commercial traders. These two components influence expected futures returns with opposite signs. The gains from providing liquidity by commercials largely offset the premium they pay for obtaining price insurance.