Asset Pricing Anomalies – Liquidity Risk Spreaders or Liquidity Risk Hedgers?

70 Pages Posted: 1 Oct 2019

See all articles by Nader Virk

Nader Virk

University of Plymouth

Hilal Butt

University of Karachi - Institute of Business Administration (IBA), Karachi

Date Written: September 18, 2019

Abstract

A unified explanation of risk and mispricing in stock returns underpinned by their aggregate liquidity risk is presented. We argue alternating liquidity exposures depict two distinct investment preferences-hedging against aggregate liquidity risk or betting on it. A three-factor model capturing these return variations is developed. Results show that our parsimonious factor model outperforms the majority of the latest asset pricing models in explaining spreads on a broad set of anomalies. Crucially, we identify that the better performance of recent models is driven by the inclusion of factors that mimic liquidity risk hedging. The imposition of stringent temporal restrictions on competing factor models shows that our model leads the pack.

Keywords: risk, mispricing, aggregate liquidity risk, asset pricing models, intertemporal-CAPM

JEL Classification: G10, G12, G15

Suggested Citation

Virk, Nader and Butt, Hilal, Asset Pricing Anomalies – Liquidity Risk Spreaders or Liquidity Risk Hedgers? (September 18, 2019). Available at SSRN: https://ssrn.com/abstract=3457311 or http://dx.doi.org/10.2139/ssrn.3457311

Nader Virk (Contact Author)

University of Plymouth ( email )

Drake Circus
Plymouth, Devon PL48AA
United Kingdom

Hilal Butt

University of Karachi - Institute of Business Administration (IBA), Karachi ( email )

University Road
Karachi, Sindh 75270
Pakistan

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