What Captures Liquidity Risk? Order Based Versus Trade Based Liquidity Measures

47 Pages Posted: 2 Mar 2007

See all articles by Lorán Chollete

Lorán Chollete

UiS Business School

Randi Naes

Norwegian Ministry of Trade and Industry

Johannes Atle Skjeltorp

Central Bank of Norway

Date Written: March 2, 2007

Abstract

Is the effect of liquidity risk on asset prices sensitive to the choice of liquidity proxy? In our study we achieve three main results. First, we extract three factors from a broad range of trade- and order based liquidity variables, and find that an order based liquidity factor is not related to realized returns while a trade based liquidity factor tied to information risk is. Second, we find evidence that the factor related to information risk explains expected returns when we estimate the theoretical liquidity-adjusted CAPM. Third, when we estimate a liquidity-augmented factor model, the Fama-French model does well in pricing stocks relative to each individual liquidity factor, but a CAPM model augmented with all our liquidity factors outraces the Fama-French model.

Keywords: Market microstructure, Common factor, Asset pricing, Liquidity factor, High frequency liquidity

JEL Classification: G12,G14

Suggested Citation

Chollete, Loran and Naes, Randi and Skjeltorp, Johannes Atle, What Captures Liquidity Risk? Order Based Versus Trade Based Liquidity Measures (March 2, 2007). Available at SSRN: https://ssrn.com/abstract=967598 or http://dx.doi.org/10.2139/ssrn.967598

Loran Chollete

UiS Business School ( email )

PB 8002
Stavanger, 4036
Norway

Randi Naes (Contact Author)

Norwegian Ministry of Trade and Industry ( email )

P.O. Box 8014 Dep
N-0030 Oslo
Norway
+47 22 24 04 34 (Phone)
+47 22 42 40 62 (Fax)

Johannes Atle Skjeltorp

Central Bank of Norway ( email )

P.O. Box 1179
Oslo, N-0107
Norway

HOME PAGE: http://www.norges-bank.no/research/skjeltorp/

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