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Liquidity Discovery and Asset Pricing

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Author Info
Duane Seppi
Michael Gallmeyer
Burton Hollifield

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Abstract

Most investors purchase securities knowing they will resell those securities in the future. Uncertainty about the preferences of future trading counter-parties causes randomness in future resale prices that we call liquidity risk. It is natural to suppose that investors are asymmetrically informed about liquidity risk. Through a process of liquidity discovery, trading volumes and prices reveal private information about future counter-party preferences. The liquidity discovery process leads to endogenous joint dynamics for prices, trading volume, volatility, and expected returns. In particular, market liquidity is a forward-looking predictor of future liquidity risk and, as such, is priced. Liquidity discovery provides an alternative explanation to transaction costs for the relationships between current market liquidity measures and future returns

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Publisher Info
Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 525.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:525

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Related research
Keywords: Liquidity; Asset Pricing;

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

Cited by:
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  1. Favero, Carlo A & Pagano, Marco & von Thadden, Ernst-Ludwig, 2008. "How Does Liquidity Affect Government Bond Yields?," CEPR Discussion Papers 6649, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Carlo Favero & Marco Pagano & Ernst-Ludwig von Thadden, 2005. "Valutation, Liquidity and Risk in Government Bond Markets," Working Papers 281, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University. [Downloadable!]
  3. J.Ramon Martinez-Resano, 2005. "Size And Heterogeneity Matter. A Microstructure-Based Analysis Of Regulation Of Secondary Markets For Government Bonds," Finance 0508007, EconWPA. [Downloadable!]
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This page was last updated on 2009-12-2.

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