This study investigates the effect of economic policy uncertainty on illiquidity return premium by using the sample of common stocks in the NYSE from 1990 to 2018. The result shows a significantly positive illiquidity return premium in the sample. On average, illiquid portfolio earns 0.597% higher monthly return than does liquid portfolio. The result further shows that the EPU index has a positive relationship with illiquidity return premium. This indicates that investors require higher compensation for holding illiquid stocks in time of high EPU than in time of low EPU. The study also shows that EPU affects illiquidity return premium through the market illiquidity channel. Particularly, EPU is associated with an increase in market illiquidity and high market illiquidity is followed by a rise in illiquidity return premium. The rise of EPU and decline of market liquidity could make investors become more risk-averse, thus they require higher compensation for illiquidity. Finally, this study shows that the relationship between EPU and illiquidity return premium is stronger when market liquidity is impaired and in crises.

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