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Price delay premium and liquidity risk

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  • Lin, Ji-Chai
  • Singh, Ajai K.
  • Sun, Ping-Wen (Steven)
  • Yu, Wen
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    Abstract

    Hou and Moskowitz (2005) document that common stocks with more price delay in reflecting information yield higher returns and that the delay premium cannot be explained by the CAPM, Fama-French three-factor model, or Carhart's four-factor model. It cannot be explained by conventional liquidity measures either. They contend that the premium is attributable to inadequate risk sharing arising from lack of investor recognition, as Merton (1987) suggests. Using a parsimonious and powerful asset pricing model developed by Liu (2006), we re-examine the issue and find that firms with greater price delay have more difficulty attracting traders (higher incidents of non-trading) and their investors face higher liquidity risk, which accounts for their anomalous returns. Our findings suggest that the price delay premium is due to systematic liquidity risk, not inadequate risk sharing.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Markets.

    Volume (Year): 17 (2014)
    Issue (Month): C ()
    Pages: 150-173

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    Handle: RePEc:eee:finmar:v:17:y:2014:i:c:p:150-173

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    Web page: http://www.elsevier.com/locate/finmar

    Related research

    Keywords: Liquidity risk; Price delay premium; Investor recognition;

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    References

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    1. Lesmond, David A & Ogden, Joseph P & Trzcinka, Charles A, 1999. "A New Estimate of Transaction Costs," Review of Financial Studies, Society for Financial Studies, vol. 12(5), pages 1113-41.
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    3. Lubos Pastor & Robert F. Stambaugh, 2001. "Liquidity Risk and Expected Stock Returns," NBER Working Papers 8462, National Bureau of Economic Research, Inc.
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    7. Merton, Robert C., 1987. "A simple model of capital market equilibrium with incomplete information," Working papers 1869-87., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    8. Bali, Turan G. & Cakici, Nusret, 2008. "Idiosyncratic Volatility and the Cross Section of Expected Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 43(01), pages 29-58, March.
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    16. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2000. "Commonality in liquidity," Journal of Financial Economics, Elsevier, vol. 56(1), pages 3-28, April.
    17. Lin, Ji-Chai & Singh, Ajai K. & Yu, Wen, 2009. "Stock splits, trading continuity, and the cost of equity capital," Journal of Financial Economics, Elsevier, vol. 93(3), pages 474-489, September.
    18. Kewei Hou & Tobias J. Moskowitz, 2005. "Market Frictions, Price Delay, and the Cross-Section of Expected Returns," Review of Financial Studies, Society for Financial Studies, vol. 18(3), pages 981-1020.
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