58 Pages Posted: 28 Jan 2003
Date Written: January 2, 2003
This paper studies equilibrium asset pricing with liquidity risk - the risk arising from unpredictable changes in liquidity over time. It is shown that a security's required return depends on its expected illiquidity and on the covariances of its own return and illiquidity with market return and market illiquidity. This gives rise to a liquidity-adjusted capital asset pricing model. Further, if a security's liquidity is persistent, a shock to its illiquidity results in low contemporaneous returns and high predicted future returns. Empirical evidence based on cross-sectional tests is consistent with liquidity risk being priced.
Keywords: liquidity risk, asset pricing
JEL Classification: G1, G12
Suggested Citation: Suggested Citation
By Yakov Amihud