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Asset pricing with liquidity risk

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  • Acharya, Viral V.
  • Pedersen, Lasse Heje

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.

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Bibliographic Info

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

Volume (Year): 77 (2005)
Issue (Month): 2 (August)
Pages: 375-410

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Handle: RePEc:eee:jfinec:v:77:y:2005:i:2:p:375-410

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Web page: http://www.elsevier.com/locate/inca/505576

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