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Liquidity and Expected Returns in a Multi-Factor Asset Pricing Model

55 Pages Posted: 17 Mar 2009 Last revised: 6 Oct 2010

Jan Schneider

University of Texas at Austin - Department of Finance

Date Written: September 30, 2010

Abstract

Several empirical studies find that illiquid firms have higher expected returns than liquid firms. I argue that this result is a puzzle that has not been resolved yet. The liquidity premium is puzzling since investors can circumvent low liquidity by trading diversified funds of illiquid firms. I develop a model that shows how a combination of cross-sectional differences in liquidity and short sale constraints generates a risk premium for illiquid firms despite the ability of investors to trade illiquid firms in large liquid baskets.

Suggested Citation

Schneider, Jan, Liquidity and Expected Returns in a Multi-Factor Asset Pricing Model (September 30, 2010). Available at SSRN: https://ssrn.com/abstract=1361260 or http://dx.doi.org/10.2139/ssrn.1361260

Jan Schneider (Contact Author)

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

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