Asset Pricing with Liquidity Risk
60 Pages Posted: 7 Mar 2003
There are 7 versions of this paper
Asset Pricing with Liquidity Risk
Asset Pricing with Liquidity Risk
Asset Pricing with Liquidity Risk
Asset Pricing with Liquidity Risk
Date Written: February 2003
Abstract
This Paper studies equilibrium asset pricing with liquidity risk (the risk arising from unpredictable changes in liquidity over time). It is shown that the required return on a security depends on its expected illiquidity, the covariances of its own return, illiquidity with market return, and market illiquidity. This gives rise to a liquidity-adjusted capital asset pricing model. Further, if a security's liquidity is persistent, a shock to its illiquidity results in low contemporaneous returns and high predicted future returns. Empirical evidence based on cross-sectional tests is consistent with liquidity risk being priced.
Keywords: Liquidity, liquidity risk, capital asset pricing model (CAPM), liquidity premium, equilibrium asset pricing
JEL Classification: D50, G11, G12, G30
Suggested Citation: Suggested Citation
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