We introduce a new class of semiparametric dynamic autoregressive models for the Amihud illiquidity measure, which captures both the long-run trend in the illiquidity series with a nonparametric component and the short-run dynamics with an autoregressive component. We develop a generalized method of moments (GMM) estimator based on conditional moment restrictions and an efficient semiparametric maximum likelihood (ML) estimator based on an iid assumption. We derive large sample properties for our estimators.

For a sample of 356 LSE stocks from the period 2013–2019, we find that common short sold capital is positively and significantly associated with one-month ahead four-factor residual return correlation, controlling for many pair characteristics, including similarities in size, book-to-market, and momentum. The relation weakens with stock illiquidity, whereas it strengthens when short positions originate from informed agents, such as hedge funds, active investors, and short sellers with high past performance.