Stock Prices, Changes in Liquidity, and Liquidity Premia
50 Pages Posted: 6 Mar 2014 Last revised: 26 Jul 2018
Date Written: July 3, 2018
This paper develops a present value framework that reflects expectations of future changes in liquidity and liquidity premia. In our framework, a liquidity premium depends explicitly on prices, dividends, costs, and returns. We find that the liquidity premium for the CRSP market portfolio is significantly priced over short horizons, but its long-horizon evidence is not clear. The implication is that liquidity provides a natural trend for prices. Liquidity shocks are so transient that liquidity should be second order in the long run. We reconcile our findings with some theoretical debate over the importance of the liquidity premium for asset pricing.
Keywords: Asset pricing; Present value; VAR; Liquidity; Liquidity premium; Impulse response functions
JEL Classification: C12, C32, G12
Suggested Citation: Suggested Citation