Time-Varying Liquidity Risk and the Cross Section of Stock Returns

53 Pages Posted: 7 Apr 2006 Last revised: 27 Jan 2013

See all articles by Akiko Watanabe

Akiko Watanabe

University of Alberta - School of Business; University of Alberta - Department of Finance and Statistical Analysis

Masahiro Watanabe

University of Alberta - School of Business; University of Alberta - Department of Finance and Statistical Analysis

Multiple version iconThere are 3 versions of this paper

Date Written: August 19, 2007

Abstract

This paper studies whether stock returns' sensitivities to aggregate liquidity fluctuations and the pricing of liquidity risk vary over time. We find that liquidity betas vary across two distinct states: one with high liquidity betas and the other with low betas. The high liquidity-beta state is short lived and characterized by heavy trade, high volatility, and a wide cross-sectional dispersion in liquidity betas. It also delivers a disproportionately large liquidity risk premium, amounting to more than twice the value premium. Our results are consistent with a model of liquidity risk in which investors face uncertainty about their trading counterparties' preferences.

Keywords: Time-varying liquidity beta, liquidity risk premium, preference uncertainty, cross-sectional asset pricing test, regime switching model

JEL Classification: G12

Suggested Citation

Watanabe, Akiko and Watanabe, Masahiro, Time-Varying Liquidity Risk and the Cross Section of Stock Returns (August 19, 2007). 8th Annual Texas Finance Festival ; EFA 2005 Moscow Meetings Paper. Available at SSRN: https://ssrn.com/abstract=895763 or http://dx.doi.org/10.2139/ssrn.895763

Akiko Watanabe

University of Alberta - School of Business ( email )

3-30A Business Building
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-0385 (Phone)
780-492-3325 (Fax)

HOME PAGE: http://www.bus.ualberta.ca/awatanabe

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

HOME PAGE: http://www.bus.ualberta.ca/awatanabe

Masahiro Watanabe (Contact Author)

University of Alberta - School of Business ( email )

School of Business - FMS
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-7343 (Phone)
780-492-3325 (Fax)

HOME PAGE: http://www.ualberta.ca/~masa/

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

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