Liquidity and Asset Prices

  • Acharya V
  • Pedersen L
  • Amihud Y
 et al. 
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We review the theories on how liquidity affects the required returns of capital assets and the empirical studies that test these theories. The theory predicts that both the level of liquidity and liquidity risk are priced, and empirical studies find the effects of liquidity on asset prices to be statistically significant and economically important, controlling for traditional risk measures and asset characteristics. Liquidity-based asset pricing empirically helps explain (1) the cross-section of stock returns, (2) how a reduction in stock liquidity result in a reduction in stock prices and an increase in expected stock returns, (3) the yield differential between on- and off-the-run Treasuries, (4) the yield spreads on corporate bonds, (5) the returns on hedge funds, (6) the valuation of closed-end funds, and (7) the low price of certain hard-to-trade securities relative to more liquid counterparts with identical cash flows, such as restricted stocks or illiquid derivatives. Liquidity can thus play a role in resolving a number of asset pricing puzzles such as the small-firm effect, the equity premium puzzle, and the risk-free rate puzzle. © 2006 Y. Amihud, H. Mendelson, and L.H. Pedersen.

Author-supplied keywords

  • Asset Pricing
  • Asset price booms and busts
  • Asset prices
  • Asset pricing
  • Bias correction
  • Bid-ask spread
  • Bid-ask spreads
  • CAPM
  • Central bank policy
  • Commonality in liquidity
  • Conditional coskewness
  • Cost of capital
  • Developed market
  • Disclosure
  • Early warning indicators
  • Earnings quality
  • Emerging market
  • Factor model
  • Fama French three factors
  • Fama-French model
  • Financial crisis
  • Financial institutions
  • Flight to liquidity
  • Frictions
  • G12
  • G15
  • G19
  • Global liquidity
  • Higher moment
  • Hong Kong stock market
  • Illiquidity
  • Information quality
  • International finance
  • Leaning against the wind
  • Liquidity
  • Liquidity commonality
  • Liquidity factor
  • Liquidity measure
  • Liquidity premium
  • Liquidity risk
  • Liquidity-adjusted CAPM
  • Liquidity-adjusted capital asset pricing model
  • Market integration
  • Market makers
  • Market segmentation
  • Market structure
  • Microstructure noise
  • Mildly segmented market
  • Momentum
  • Principal component analysis
  • Return premium
  • Risk
  • Seasonality
  • Signaling approach
  • Trading speed
  • Transaction costs
  • Uncertainty
  • VIX
  • Volatility
  • Welfare
  • Zero return
  • and Crises

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  • Viral V. Acharya

  • Lasse Heje Pedersen

  • Yakov Amihud

  • Haim Mendelson

  • Lasse Heje Pedersen

  • John H Cochrane

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