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What captures liquidity risk? A comparison of trade and order based liquidity factors

Author

Listed:
  • Lorán Chollete

    () (Norwegian School of Economics and Business)

  • Randi Næs

    () (Norges Bank (Central Bank of Norway))

  • Johannes A. Skjeltorp

    () (Norges Bank (Central Bank of Norway))

Abstract

Is the effect of liquidity risk on asset prices sensitive to our choice of liquidity proxy? In addressing this fundamental question, we achieve two main results. First, when we estimate factor models on a broad range of liquidity measures we uncover a profound distinction between trade and order based liquidity. Second, although the order based factor provides a better signal of available liquidity, we find that only the factor related to information risk explains expected returns both in a theoretical liquidity-CAPM model and in a linear pricing framework. Our results suggest a surprising fragility of liquidity-based asset pricing.

Suggested Citation

  • Lorán Chollete & Randi Næs & Johannes A. Skjeltorp, 2007. "What captures liquidity risk? A comparison of trade and order based liquidity factors," Working Paper 2007/03, Norges Bank.
  • Handle: RePEc:bno:worpap:2007_03
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    File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2007/WP-20073/
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    Citations

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    Cited by:

    1. Björn Hagströmer & Richard G. Anderson & Jane M. Binner & Birger Nilsson, 2009. "Dynamics in systematic liquidity," Working Papers 2009-025, Federal Reserve Bank of St. Louis.
    2. Chollete, Lorán, 2008. "The Propagation of Financial Extremes: An Application to Subprime Market Spillovers," Discussion Papers 2008/2, Norwegian School of Economics, Department of Business and Management Science.
    3. Dudek, Jérémy, 2013. "Illiquidité, contagion et risque systémique," Economics Thesis from University Paris Dauphine, Paris Dauphine University, number 123456789/13236 edited by Le Fol, Gaëlle, June.

    More about this item

    Keywords

    CPAM; Liquidity risk; Liquidity factor; Order based measure; Trade based measure; Information risk;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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