Liquidity Level or Liquidity Risk? Evidence from the Financial Crisis

Abstract:     
This paper distinguishes between a stock's liquidity (liquidity level), as measured by the average cost of trading it, and its liquidity beta (liquidity risk), as measured by the covariation of its return with unexpected changes in aggregate liquidity. Although considered safe assets in general, liquid stocks underperformed illiquid stocks during the financial crisis of 2008--2009. The performance of stocks during the crisis can be better explained by their historical liquidity betas. These findings therefore highlight the importance of accounting for both liquidity level and liquidity risk in risk-management applications.

Number of Pages in PDF File: 19

Keywords: Liquidity risk, Liquidity Level, Asset pricing, Risk Management, Financial Crisis

JEL Classification: G12, G14, G23

working papers series