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Pricing Liquidity Risk with Heterogeneous Investment Horizons

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  • Beber, Alessandro
  • Driessen, Joost
  • Tuijp, Patrick

Abstract

We develop a liquidity-based asset pricing model featuring investors with heterogeneous investment horizons and stochastic transaction costs. In an equilibrium where all investors invest in all assets (integration), we find that the existence of investors with heterogeneous horizons, as opposed to homogeneous horizons, reduces the importance of liquidity risk relative to the standard CAPM market risk and generates a more complex effect of expected liquidity. In an equilibrium where short-term investors do not invest in some more illiquid assets (partial segmentation), our model generates an additional segmentation premium for these assets. We estimate the model for the cross-section of U.S. stocks using GMM and find that our heterogeneous-horizon asset pricing model fares better than a standard liquidity-adjusted CAPM. The segmented version of our model delivers the best cross-sectional fit and generates a substantial effect of expected liquidity on expected returns.

Suggested Citation

  • Beber, Alessandro & Driessen, Joost & Tuijp, Patrick, 2011. "Pricing Liquidity Risk with Heterogeneous Investment Horizons," CEPR Discussion Papers 8710, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:8710
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    2. Vayanos, Dimitri & Wang, Jiang, 2012. "Market liquidity - theory and empirical evidence," LSE Research Online Documents on Economics 119044, London School of Economics and Political Science, LSE Library.
    3. Schuster, Philipp & Trapp, Monika & Uhrig-Homburg, Marliese, 2013. "A heterogeneous agents equilibrium model for the term structure of bond market liquidity," CFR Working Papers 13-05 [rev.], University of Cologne, Centre for Financial Research (CFR).
    4. Xuanjuan Chen & Jing-Zhi Huang & Zhenzhen Sun & Tong Yao & Tong Yu, 2020. "Liquidity Premium in the Eye of the Beholder: An Analysis of the Clientele Effect in the Corporate Bond Market," Management Science, INFORMS, vol. 66(2), pages 932-957, February.
    5. Boutabba, Mohamed Amine & Rannou, Yves, 2022. "Investor strategies in the green bond market: The influence of liquidity risks, economic factors and clientele effects," International Review of Financial Analysis, Elsevier, vol. 81(C).
    6. Guan, Ruiqi & Jacoby, Gady & Lu, Xiaomeng & Wan, Fang & Zhang, Qi, 2023. "Trauma and investment horizon: Evidence from a representative China equity investor behavior survey," Finance Research Letters, Elsevier, vol. 57(C).
    7. Albuquerque, Rui & Song, Shiyun & Yao, Chen, 2017. "The Price Effects of Liquidity Shocks: A Study of SEC’s Tick-Size Experiment," CEPR Discussion Papers 12486, C.E.P.R. Discussion Papers.
    8. Schuster, Philipp & Trapp, Monika & Uhrig-Homburg, Marliese, 2016. "A heterogeneous agents equilibrium model for the term structure of bond market liquidity," CFR Working Papers 13-05 [rev.2], University of Cologne, Centre for Financial Research (CFR).
    9. Mohamed Amine Boutabba & Yves Rannou, 2020. "Investor strategies and Liquidity Premia in the European Green Bond market," Post-Print hal-02544451, HAL.
    10. de Jong, F.C.J.M. & Driessen, J.J.A.G., 2015. "Can large long-term investors capture illiquidity premiums," Other publications TiSEM 9c92b978-0099-44d3-9aab-8, Tilburg University, School of Economics and Management.
    11. Alexander M. Chinco & Mao Ye, 2017. "Investment-Horizon Spillovers," NBER Working Papers 23650, National Bureau of Economic Research, Inc.
    12. Jansen, Kristy, 2021. "Essays on institutional investors, portfolio choice, and asset prices," Other publications TiSEM fd998408-d282-4e0f-b542-4, Tilburg University, School of Economics and Management.
    13. Driessen, Joost & Nijman, Theodore E. & Simon, Zorka, 2022. "A simple approach to estimate long-term interest rates," SAFE Working Paper Series 238, Leibniz Institute for Financial Research SAFE, revised 2022.

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    More about this item

    Keywords

    Liquidity risk; Investment horizon;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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