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Asset Pricing with Liquidity Risk

Authors: Acharya, Viral V.
Pedersen, Lasse Heje
Keywords: Liquidity risk;Liquidity-adjusted CAPM;Flight to liquidity;Frictions;Transaction costs
Issue Date: 11-Jun-2004
Series/Report no.: S-DRP-05-09
Abstract: This paper solves explicitly a simple equilibrium model with liquidity risk. In our liquidityadjusted capital asset pricing model, a security’s required return depends on its expected liquidity as well as on the covariances of its own return and liquidity with the market return and liquidity. In addition, a persistent negative shock to a security’s liquidity results in low contemporaneous returns and high predicted future returns. The model provides a unified framework for understanding the various channels through which liquidity risk may affect asset prices. Our empirical results shed light on the total and relative economic significance of these channels and provide evidence of flight to liquidity. r 2005 Elsevier B.V. All rights reserved.
Appears in Collections:Derivatives Research

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