This paper examined the existence of illiquidity premiums in Taiwan stock markets during 1982-2016. First, the illiquidity premium was calculated with the method of Amihud (2014) in a whole period and its three sub periods, and then a five-factor model was formed by adding the new risk premium to the traditional Fama-French-Carhart four-factor model. Then quint portfolios the illiquidity measure by Amihud ( 2002) in an ascending order and applies factor models to explore the relationship between stock returns and illiquidity premium. The empirical results indicated that the five-factor model increased the relative explanatory power compared to the traditional four-factor model. For the higher illiquidity portfolios, the illiquidity premium demonstrated significantly positive effects on stock returns and the five-factor model showed relatively smaller alphas, which in turn proved the existence of market illiquidity premiums. The empirical results are expected to enhance the understanding of the functioning of illiquidity on developed markets in the literature, and also add more evidence on the emerging market settings.Contribution/ Originality: This paper contributes to the existing literature of liquidity study, which is mostly done on developed markets, by using the Taiwan stock exchanges, a setting of a typical emerging market. The empirical results are expected to enhance the understanding of the functioning of illiquidity in both developed and emerging markets.

This study empirically examines the illiquidity premium of Taiwan stock markets and its relationship with monetary policies. We find that commonly used illiquidity measures are generally sensitive and capable of capturing market illiquidity, particularly during the most volatile periods. Evidence shows that unconditional illiquidity is significantly priced across three illiquidity measures during the sample period. Aggregate market illiquidity innovations are noticeably affected by monetary policies. The results of Granger causality tests reveal that expansive monetary policy improves market illiquidity, whereas restrictive policy adversely affects market liquidity.