What Drives the Liquidity Premium: Factors or Characteristics?

40 Pages Posted: 20 Feb 2011

See all articles by Pin-Huang Chou

Pin-Huang Chou

National Central University

Kuan-Cheng Ko

National Chi Nan University - College of Management

K.C. John Wei

Hong Kong Polytechnic University

Date Written: February 10, 2011

Abstract

We investigate whether the liquidity premium is better explained by the risk-based model or the characteristic-based model. Based on three widely-used liquidity measures that are supposed to reflect different aspects of liquidity, we find that liquidity as a characteristic carries a significant liquidity premium that is beyond the size and book-to-market effects. In addition, liquidity as a factor does not yield a significant risk premium beyond that provided by Fama and French’s (1993) three factors. Finally, in direct comparisons under a liquidity-augmented two-factor capital asset-pricing model, the liquidity premium is better characterized by a characteristic-based model rather than a risk-based model, especially for the Amihud (2002) liquidity measure and for the post-1964 period.

Keywords: Liquidity Premium, Factor Model, Characteristic-Based Model

JEL Classification: C1, G1, G2

Suggested Citation

Chou, Pin-Huang and Ko, Kuan-Cheng and Wei, Kuo-Chiang (John), What Drives the Liquidity Premium: Factors or Characteristics? (February 10, 2011). Available at SSRN: https://ssrn.com/abstract=1765003 or http://dx.doi.org/10.2139/ssrn.1765003

Pin-Huang Chou

National Central University ( email )

Department of Finance
Taoyuan, 32001
Taiwan
886-3-4227151 ext 66270 (Phone)
886-3-4252961 (Fax)

HOME PAGE: http://mgt.ncu.edu.tw/~choup

Kuan-Cheng Ko (Contact Author)

National Chi Nan University - College of Management ( email )

Taiwan
886-49-2910960 ext. 4695 (Phone)
886-49-2914511 (Fax)

Kuo-Chiang (John) Wei

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

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