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Liquidity Risk and Expected Stock Returns

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Author Info
Lubos Pastor
Robert F. Stambaugh

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Abstract

This study investigates whether market-wide liquidity is a state variable important for asset pricing. We find that expected stock returns are related cross-sectionally to the sensitivities of returns to fluctuations in aggregate liquidity. Our monthly liquidity measure, an average of individual-stock measures estimated with daily data, relies on the principle that order flow induces greater return reversals when liquidity is lower. Over a 34-year period, the average return on stocks with high sensitivities to liquidity exceeds that for stocks with low sensitivities by 7.5% annually, adjusted for exposures to the market return as well as size, value, and momentum factors.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8462.

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Date of creation: Sep 2001
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Publication status: published as Pastor, Lubos and Robert F. Stambaugh. "Liquidity Risk And Expected Stock Returns," Journal of Political Economy, 2003, v111(3,Jun), 642-685.
Handle: RePEc:nbr:nberwo:8462

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G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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  23. Constantinides, George M, 1986. "Capital Market Equilibrium with Transaction Costs," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 842-62, August. [Downloadable!] (restricted)
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