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Consumption, liquidity and the cross-sectional variation of expected returns

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Author Info

  • Elena Márquez

    ()
    (Dpto. Economía Aplicada III)

  • Belén Nieto Doménech

    (Universidad de Alicante)

  • Gonzalo Rubio Irigoyen

    (Universidad del País Vasco)

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    Abstract

    Recent papers in asset pricing have added a market-wide liquidity factor to traditional portfolio-based or factor models. However, none of these papers has reported any evidence on how aggregate liquidity behaves together with consumption growth risk. This paper covers this gap by providing a comprehensive analysis of the cross-sectional variation of average returns under ultimate consumption risk and market-wide illiquidity shocks. It derives closed-form expressions for consumption-based stochastic discount factors adjusted by aggregate illiquidity shocks and tests alternative model specifications. We find that market-wide illiquidity risk seems to be especially useful in explaining the size-based cross-sectional differences of average returns. We also find a strongly negative and highly significant illiquidity risk premium under recursive preferences for the first quarter of the year suggesting a time-varying behaviour of the market-wide illiquidity premium.

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    File URL: http://www.ivie.es/downloads/docs/wpasad/wpasad-2010-24.pdf
    File Function: Fisrt version / Primera version, 2010
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    Bibliographic Info

    Paper provided by Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) in its series Working Papers. Serie AD with number 2010-24.

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    Length: 48 pages
    Date of creation: Jul 2010
    Date of revision:
    Publication status: Published by Ivie
    Handle: RePEc:ivi:wpasad:2010-24

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    Related research

    Keywords: stochastic discount factor; ultimate consumption risk; market-wide liquidity; illiquidity premium seasonality.;

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    References

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    1. Climent Quintana Domeque & Sonia Oreffice, 2010. "Anthropometry and socioeconomics in the couple: evidence from the PSID," Working Papers. Serie AD, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) 2010-16, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    2. Francesco Turino, 2009. "Non-price Competition, Real Rigidities and Inflation Dynamics," Working Papers. Serie AD, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) 2009-17, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    3. José J. Sempere Monerris & Rafael Moner Colonques & Amparo Urbano Salvador, 2010. "Trade liberalization in vertically related markets," Working Papers. Serie AD, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) 2010-09, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    4. Lilia Maliar & Fernando Valli & Serguei Maliar, 2009. "Solving the incomplete markets model with aggregate uncertainty using the Krusell-Smith algorithm," Working Papers. Serie AD, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) 2009-03, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    5. Martin Menner, 2007. "The role of search frictions for output and inflation dynamics: a Bayesian assessment," Economics Working Papers we076235, Universidad Carlos III, Departamento de Economía.
    6. Cuberes, David & Dougan, William, 2009. "How Endogenous Is Money? Evidence from a New Microeconomic Estimate," MPRA Paper 17744, University Library of Munich, Germany.
    7. Andres, Luis & Cuberes, David & Diouf, Mame Astou & Serebrisky, Tomas, 2007. "Diffusion of the internet : a cross-country analysis," Policy Research Working Paper Series 4420, The World Bank.
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