Asset Pricing with Liquidity Risk

60 Pages Posted: 7 Mar 2003

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Lasse Heje Pedersen

AQR Capital Management, LLC; Copenhagen Business School - Department of Finance; New York University (NYU); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 7 versions of this paper

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

Acharya, Viral V. and Acharya, Viral V. and Pedersen, Lasse Heje, Asset Pricing with Liquidity Risk (February 2003). Available at SSRN: https://ssrn.com/abstract=385907

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business ( email )

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New York University (NYU) - Department of Finance ( email )

Stern School of Business
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Centre for Economic Policy Research (CEPR) ( email )

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National Bureau of Economic Research (NBER) ( email )

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Lasse Heje Pedersen (Contact Author)

AQR Capital Management, LLC ( email )

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United States

Copenhagen Business School - Department of Finance ( email )

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Frederiksberg, DK-2000
Denmark

New York University (NYU) ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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