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
New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)
Journal of Financial Economics, Forthcoming
This paper solves explicitly an equilibrium asset pricing model with liquidity risk - the risk arising from unpredictable changes in liquidity over time. In our liquidity-adjusted capital asset pricing model, a security's required return depends on its expected liquidity, as well as on the covariances of its own return and liquidity with market return and market liquidity. In addition, the model shows how a negative shock to a security's liquidity, if it is persistent, results in low contemporaneous returns and high predicted future returns. The model provides a simple, unified framework for understanding the various channels through which liquidity risk may affect asset prices. Our empirical results shed light on the total and relative economic significance of these channels.
Keywords: Liquidity, liquidity risk, frictions, transaction costs, flight to liquidity
JEL Classification: G0, G1, G12Accepted Paper Series
Date posted: December 16, 2004
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