The Liquidity-Augmented CAPM over 1926 to 1963

Abstract

This paper examines the two-factor model of Liu (2006) using the recent CRSP compilation of daily trading volume data between 1926 and 1962. I find that the liquidity premium is as strong for the early period as for the post 1963-period, and it is the most significant and persistent premium compared with those associated with size, book-to-market, turnover, return-to-volume ratio, and past return. The two-factor model performs well in explaining the cross-section of stock returns. The evidence suggests that the original results of Liu are robust to the earlier period. In addition, liquidity as a firm characteristic lacks significant predictive power beyond liquidity risk.

Keywords: Trading continuity, liquidity risk, liquidity premium

JEL Classification: G12, G14