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Liquidity Risk and Expected Stock Returns

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  • Lubos Pastor
  • Robert F. Stambaugh

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.

Suggested Citation

  • Lubos Pastor & Robert F. Stambaugh, 2001. "Liquidity Risk and Expected Stock Returns," NBER Working Papers 8462, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:8462
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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