Asset Prices and Asset Correlations in Illiquid Markets

24 Pages Posted: 1 Dec 2004

See all articles by Celso Brunetti

Celso Brunetti

Board of Governors of the Federal Reserve System

Alessio Caldarera

PIMCO Europe Ltd.

Date Written: November 2004

Abstract

We build a new asset pricing framework to study the effects of aggregate illiquidity on asset prices, volatilities and correlations. The Black-Scholes economy is obtained in our framework as the limiting case of perfectly liquid markets. The model is consistent with empirical studies on the effects of illiquidity on asset returns, volatilities and correlations. We present the model, study its qualitative properties and estimate the stocks' sensitivities to aggregate liquidity (betas) using nine years data for 24 randomly sampled stocks traded on the NYSE. These sensitivity parameters (betas) determine the effect that aggregate illiquidity has on expected returns, volatilities, correlations, CAPM-betas and Sharpe ratios. We find clear capitalization and sector patterns for the liquidity betas.

Keywords: Market Liquidity, Volatilities, Correlations, Asset Pricing, GMM

JEL Classification: G12, G14, C30

Suggested Citation

Brunetti, Celso and Caldarera, Alessio, Asset Prices and Asset Correlations in Illiquid Markets (November 2004). Available at SSRN: https://ssrn.com/abstract=625184 or http://dx.doi.org/10.2139/ssrn.625184

Celso Brunetti (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Alessio Caldarera

PIMCO Europe Ltd. ( email )

Nations House
103 Wigmore Street
London W1U 1QS
United Kingdom

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