Discussion paper

DP3749 Asset Pricing with Liquidity Risk

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.

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Citation

Acharya, V and L Pedersen (2003), ‘DP3749 Asset Pricing with Liquidity Risk‘, CEPR Discussion Paper No. 3749. CEPR Press, Paris & London. https://cepr.org/publications/dp3749