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Liquidity Risk and Expected Stock Returns

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  • Stambaugh, Robert F.
  • Pástor, LuboÅ¡

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

  • Stambaugh, Robert F. & Pástor, LuboÅ¡, 2002. "Liquidity Risk and Expected Stock Returns," CEPR Discussion Papers 3494, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:3494
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Asset pricing; Liquidity risk; Expected returns;
    All these keywords.

    JEL classification:

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

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