The Pricing of Liquidity Factors

Abstract

This paper explores the role of liquidity in asset pricing by analyzing whether liquidity factors provide unique information that the Fama-French factors, especially the size factor (SMB), do not capture. Using US stock market data from 1963 through 2023, we construct six liquidity factors and evaluate their pricing power. We find that three of these factors—liquidity costs (LIQ), liquidity commonality (COM), and sensitivity to market uncertainty (LMU)—offer distinct pricing information not subsumed by the size factor. Overall, liquidity factors, while sharing a high correlation with the size factor, often provide superior explanatory power for stock returns.

Keywords: JEL classification: G11, G12, G14 Liquidity, Asset pricing, Size effect, Fama-French factors, Risk-adjusted returns

JEL Classification: G11, G12, G14