Working Paper: CEPR ID: DP3494
Authors: Lubos Pstor; Robert F. Stambaugh
Abstract: This study investigates whether market-wide liquidity is a state variable important for asset pricing. We find that expected stock returns are related cross-sectionally to the sensitivities of returns to fluctuations in aggregate liquidity. Our monthly liquidity measure, an average of individual-stock measures estimated with daily data, relies on the principle that order flow induces greater return reversals when liquidity is lower. Over a 34-year period, the average return on stocks with high sensitivities to liquidity exceeds that for stocks with low sensitivities by 7.5% annually, adjusted for exposures to the market return as well as size, value, and momentum factors.
Keywords: Asset Pricing; Expected Returns; Liquidity Risk
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Expected stock returns (G17) | Liquidity risk (G33) |
| Liquidity betas (C46) | Expected stock returns (G17) |
| Liquidity risk factor (G33) | Expected stock returns (G17) |
| Liquidity measures (E41) | Expected stock returns (G17) |