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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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3749.

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Date of creation: Feb 2003
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Handle: RePEc:cpr:ceprdp:3749

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Keywords: capital asset pricing model (CAPM); equilibrium asset pricing; liquidity; liquidity premium; liquidity risk;

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References

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