Time-Varying Liquidity Risk and the Cross Section of Stock Returns
Review of Financial Studies, Vol. 21, Issue 6, 2008
Posted: 26 May 2013 Last revised: 4 Jun 2013
Date Written: June 5, 2006
This paper studies whether stock returns’ sensitivities to aggregate liquidity ﬂuctuations and the pricing of liquidity risk vary over time. We ﬁnd that liquidity betas vary across two distinct states, one with high liquidity betas and the other with low betas. The high liquidity beta state is short lived, and is associated with heavy trade, high volatility, and a wide crosssectional dispersion in liquidity betas. The liquidity risk premium also changes over time and is delivered primarily in the high liquidity-beta state. The conditional liquidity risk premium is statistically signiﬁcant and economically large, rendering more than twice the value premium.
Keywords: conditional pricing of systematic liquidity risk, preference uncertainty, cross sectional asset pricing, regime switching models
JEL Classification: G12
Suggested Citation: Suggested Citation