Time-Varying Liquidity Risk and the Cross Section of Stock Returns

Review of Financial Studies, Vol. 21, Issue 6, 2008

University of Alberta School of Business Research Paper No. 2013-231

Posted: 26 May 2013 Last revised: 4 Jun 2013

See all articles by Akiko Watanabe

Akiko Watanabe

University of Alberta - School of Business; University of Alberta - Department of Finance and Statistical Analysis

Masahiro Watanabe

University of Alberta - School of Business; University of Alberta - Department of Finance and Statistical Analysis

Date Written: June 5, 2006

Abstract

This paper studies whether stock returns’ sensitivities to aggregate liquidity fluctuations and the pricing of liquidity risk vary over time. We find that liquidity betas vary across two distinct states, one with high liquidity betas and the other with low betas. The high liquidity beta state is short lived, and is associated with heavy trade, high volatility, and a wide crosssectional dispersion in liquidity betas. The liquidity risk premium also changes over time and is delivered primarily in the high liquidity-beta state. The conditional liquidity risk premium is statistically significant and economically large, rendering more than twice the value premium.

Keywords: conditional pricing of systematic liquidity risk, preference uncertainty, cross sectional asset pricing, regime switching models

JEL Classification: G12

Suggested Citation

Watanabe, Akiko and Watanabe, Masahiro, Time-Varying Liquidity Risk and the Cross Section of Stock Returns (June 5, 2006). Review of Financial Studies, Vol. 21, Issue 6, 2008, University of Alberta School of Business Research Paper No. 2013-231, Available at SSRN: https://ssrn.com/abstract=2269865

Akiko Watanabe (Contact Author)

University of Alberta - School of Business ( email )

3-30A Business Building
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-0385 (Phone)
780-492-3325 (Fax)

HOME PAGE: http://www.bus.ualberta.ca/awatanabe

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

HOME PAGE: http://www.bus.ualberta.ca/awatanabe

Masahiro Watanabe

University of Alberta - School of Business ( email )

School of Business - FMS
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-7343 (Phone)
780-492-3325 (Fax)

HOME PAGE: http://www.ualberta.ca/~masa/

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

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