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Liquidity Risk and Asset Pricing

Author

Listed:
  • Li, Hongtao
  • Novy-Marx, Robert
  • Velikov, Mihail

Abstract

Pastor and Stambaugh’s (PS 2003) aggregate liquidity innovations can be closely replicated, as can their traded factor based on historically estimated liquidity betas, which performs even stronger out of sample. This factor’s performance is highly sensitive to construction details, however, and exhibits significantly weaker performance when rebalanced at its natural monthly frequency, or when constructed using either more or less extreme sorts. Their predicted liquidity risk factor is more difficult to replicate, and difficult to interpret because characteristics chosen to predict liquidity risk introduce mechanical relations to other known anomalies. Contrary to the claims of PS, liquidity risk appears essentially unrelated to momentum.

Suggested Citation

  • Li, Hongtao & Novy-Marx, Robert & Velikov, Mihail, 2019. "Liquidity Risk and Asset Pricing," Critical Finance Review, now publishers, vol. 8(1-2), pages 223-255, December.
    • Handle: RePEc:now:jnlcfr:104.00000076
    DOI: 10.1561/104.00000076
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    Citations

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    Cited by:

    1. Wu, Ying, 2019. "Asset pricing with extreme liquidity risk," Journal of Empirical Finance, Elsevier, vol. 54(C), pages 143-165.
    2. Wei Liu & James W. Kolari, 2022. "Multifactor Market Indexes," JRFM, MDPI, vol. 15(4), pages 1-26, March.
    3. Snigaroff, Robert & Wroblewski, David, 2021. "Earnings and liquidity factors," The Quarterly Review of Economics and Finance, Elsevier, vol. 80(C), pages 508-523.
    4. Novy-Marx, Robert & Velikov, Mihail, 2022. "Betting against betting against beta," Journal of Financial Economics, Elsevier, vol. 143(1), pages 80-106.
    5. Andrew Y. Chen & Tom Zimmermann, 2022. "Open Source Cross-Sectional Asset Pricing," Critical Finance Review, now publishers, vol. 11(2), pages 207-264, May.
    6. Hilal Anwar Butt & Nader Shahzad Virk, 2022. "Momentum crashes and variations to market liquidity," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(2), pages 1899-1911, April.
    7. Ma, Xiuli & Zhang, Xindong & Liu, Weimin, 2021. "Further tests of asset pricing models: Liquidity risk matters," Economic Modelling, Elsevier, vol. 95(C), pages 255-273.
    8. Amihud, Yakov & Noh, Joonki, 2021. "The pricing of the illiquidity factor’s conditional risk with time-varying premium," Journal of Financial Markets, Elsevier, vol. 56(C).

    More about this item

    Keywords

    Asset pricing; Liquidity; Factor models; Momentum;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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