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Asset Pricing with Liquidity Risk

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Author Info
Acharya, Viral V
Pedersen, Lasse Heje

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Abstract

This Paper solves explicitly a simple equilibrium asset pricing model with liquidity risk – the risk arising from unpredictable changes in liquidity over time. In our liquidity-adjusted capital asset pricing model, a security’s required return depends on its expected liquidity as well as on the covariances of its own return and liquidity with market return and market liquidity. In addition, the model shows how a negative shock to a security’s liquidity, if it is persistent, results in low contemporaneous returns and high predicted future returns. The model provides a simple, unified framework for understanding the various channels through which liquidity risk may affect asset prices. Our empirical results shed light on the total and relative economic significance of these channels.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4718.

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Date of creation: Oct 2004
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Handle: RePEc:cpr:ceprdp:4718

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Related research
Keywords: asset pricing; frictions; liquidity; liquidity risk; transaction costs;

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Find related papers by JEL classification:
G00 - Financial Economics - - General - - - General
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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