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Asset pricing with liquidity risk

Subject

Finance

Publishing details

Authors / Editors

Acharya V;Pedersen L H

Publication Year

2003

Abstract

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.

Publication Research Centre

Institute of Finance and Accounting

Series Number

FIN 373

Series

IFA Working Paper

Available on ECCH

No


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