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# Asset Prices and Asset Correlations in Illiquid Markets

## Author

Listed:
• Alessio Caldarera
• Celso Brunetti

() (Finance Johns Hopkins University)

## Abstract

We build a new asset pricing framework to study the effects of aggregate illiquidity on asset prices, volatilities and correlations. In our framework the Black-Scholes economy is obtained as the limiting case of perfectly liquid markets. The model is consistent with empirical studies on the effects of illiquidity on asset returns, volatilities and correlations. We present the model, study its qualitative properties and estimate stocks' sensitivities to aggregate liquidity ($\beta$s) using nine years data for 24 randomly sampled stocks traded on the NYSE. These sensitivity parameters ($\beta$s) determine the effect that aggregate illiquidity has on expected returns, volatilities, correlations, CAPM-betas and Sharpe ratios. We find clear capitalization and sector patterns for liquidity $\beta$s.
(This abstract was borrowed from another version of this item.)

## Suggested Citation

• Alessio Caldarera & Celso Brunetti, 2005. "Asset Prices and Asset Correlations in Illiquid Markets," 2005 Meeting Papers 288, Society for Economic Dynamics.
• Handle: RePEc:red:sed005:288
as

File URL: http://myweb.jhu.edu/celsob/BrunettiCaldarera6.pdf
File Function: main text

## References listed on IDEAS

as
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## Citations

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Cited by:

1. Feng, Shih-Ping & Hung, Mao-Wei & Wang, Yaw-Huei, 2014. "Option pricing with stochastic liquidity risk: Theory and evidence," Journal of Financial Markets, Elsevier, vol. 18(C), pages 77-95.
2. Feng, Shih-Ping & Hung, Mao-Wei & Wang, Yaw-Huei, 2016. "The importance of stock liquidity on option pricing," International Review of Economics & Finance, Elsevier, vol. 43(C), pages 457-467.
3. Marsili, Matteo & Raffaelli, Giacomo & Ponsot, Benedicte, 2009. "Dynamic instability in generic model of multi-assets markets," Journal of Economic Dynamics and Control, Elsevier, vol. 33(5), pages 1170-1181, May.

### Keywords

Market Liquidity; Asset Pricing; Volatilities; Correlations; GMM;

### 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
• C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General

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