DP3749 Asset Pricing with Liquidity Risk
|Author(s):||Viral V. Acharya, Lasse Heje Pedersen|
|Publication Date:||February 2003|
|Keyword(s):||capital asset pricing model (CAPM), equilibrium asset pricing, liquidity, liquidity premium, liquidity risk|
|JEL(s):||D50, G11, G12, G30|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=3749|
This Paper studies equilibrium asset pricing with liquidity risk (the risk arising from unpredictable changes in liquidity over time). It is shown that the required return on a security depends on its expected illiquidity, the covariances of its own return, illiquidity with market return, and market illiquidity. This gives rise to a liquidity-adjusted capital asset pricing model. Further, if a security's liquidity is persistent, a shock to its illiquidity results in low contemporaneous returns and high predicted future returns. Empirical evidence based on cross-sectional tests is consistent with liquidity risk being priced.