Liquidity Risk and Expect Stock Returns

Posted: 22 Jul 2003

See all articles by Lubos Pastor

Lubos Pastor

University of Chicago - Booth School of Business

Robert F. Stambaugh

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Abstract

This study investigates whether marketwide liquidity is a state variable important for asset pricing. We find that expected stock returns are related cross-sectionally to the sensitivities of returns to fluctuations in aggregate liquidity. Our monthly liquidity measure, an average of individual-stock measures estimated with daily data, relies on the principle that order flow induces greater return reversals when liquidity is lower. From 1966 through 1999, the average return on stocks with high sensitivities to liquidity exceeds that for stocks with low sensitivities by 7.5 percent annually, adjusted for exposures to the market return as well as size, value, and momentum factors. Furthermore, a liquidity risk factor accounts for half of the profits to a momentum strategy over the same 34-year period.

Suggested Citation

Pastor, Lubos and Stambaugh, Robert F., Liquidity Risk and Expect Stock Returns. Available at SSRN: https://ssrn.com/abstract=398021

Lubos Pastor (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
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773-834-4080 (Phone)
773-702-0458 (Fax)

HOME PAGE: http://www.ChicagoGSB.edu/fac/lubos.pastor/

Robert F. Stambaugh

University of Pennsylvania - The Wharton School ( email )

The Wharton School, Finance Department
University of Pennsylvania
Philadelphia, PA 19104-6367
United States
215-898-5734 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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