Asset Pricing with Liquidity Risk
Viral V. Acharya
New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance
Lasse Heje Pedersen
AQR Capital Management, LLC; Copenhagen Business School - Department of Finance; New York University (NYU); Centre for Economic Policy Research (CEPR)
January 2, 2003
This paper studies equilibrium asset pricing with liquidity risk - the risk arising from unpredictable changes in liquidity over time. It is shown that a security's required return depends on its expected illiquidity and on the covariances of its own return and 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.
Number of Pages in PDF File: 58
Keywords: liquidity risk, asset pricing
JEL Classification: G1, G12
Date posted: January 28, 2003
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