Working Paper: NBER ID: w10814
Authors: Viral V. Acharya; Lasse Heje Pedersen
Abstract: This paper solves explicitly an equilibrium asset pricing model with liquidity risk -- the risk arising from unpredictable changes in liquidity over time. In our liquidity-adjusted 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 market return and market liquidity. In addition, the model shows how a negative shock to a security's liquidity, if it is persistent, results in low contemporaneous returns and high predicted future returns. The model provides a simple, 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.
Keywords: Asset Pricing; Liquidity Risk
JEL Codes: G0; G1; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity risk (G33) | asset returns (G19) |
| expected illiquidity (G33) | expected return (G17) |
| net beta (C46) | expected return (G17) |
| negative shock to liquidity (E44) | contemporaneous returns (G14) |
| negative shock to liquidity (E44) | future returns (G17) |
| liquidity risk (G33) | risk premium differences (G19) |
| commonality in liquidity (G33) | return premium (G22) |
| return sensitivity to market liquidity (G19) | return premium (G22) |
| liquidity sensitivity to market returns (E44) | return premium (G22) |
| liquidity (E41) | future returns (G17) |
| liquidity (E41) | contemporaneous returns (G14) |