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Liquidity and Asset Prices
Yakov Amihud,Haim Mendelson,Lasse Heje Pedersen +2 more
- 01 Dec 2005
TL;DR: In this paper, the authors review the theories on how liquidity affects the required returns of capital assets and the empirical studies that test these theories and find the effects of liquidity on asset prices to be statistically significant and economically important, controlling for traditional risk measures and asset characteristics.
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Abstract: 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.
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Citations
Presidential Address: Discount Rates
TL;DR: Discount-rate variation is the central organizing question of current asset-pricing research as discussed by the authors, and a survey of discount-rate theories and applications can be found in the survey.
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How Sovereign is Sovereign Credit Risk
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References
The Expected Illiquidity Premium: Evidence from Equity Index-Linked Bonds
Elroy Dimson,Bernd Hanke +1 more
TL;DR: In this article, the authors examine a set of equity index-linked bonds that provide the same payoff as an in- vestment in an equity index, but are relatively illiquid, and demonstrate that these securities sell at a discount relative to their underlying value and hence have higher expected returns.
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Search and endogenous concentration of liquidity in asset markets
TL;DR: There exists a "clientele" equilibrium where one market has more buyers and sellers, lower search times, higher trading volume, higher prices, and short-horizon investors, implying that the concentration of liquidity in one asset is socially desirable.
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The Joint Dynamics of Liquidity, Returns, and Volatility Across Small and Large Firms
TL;DR: In this article, the authors explore liquidity spillovers in market-cap based portfolios of NYSE stocks and find that volatility and liquidity innovations in either sector are informative in predicting liquidity shifts in the other.
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Liquidity Premium and a Two-factor Model
TL;DR: This article examined the role of liquidity risk in explaining the cross-section of asset returns using a new measure of liquidity that captures its multi-dimensional nature and found that a two-factor (market and liquidity) model performs better in explaining stock returns than the CAPM and the Fama-French three-factor model.
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On the Excess Returns to Illiquidity
Robert Novy-Marx
- 01 Jan 2004
TL;DR: The authors argue that the high expected returns observed on illiquid assets should be expected theoretically, but are not actually a premium for illiquidity, per se, and that illiquidities, like size, is a proxy for any unobserved risk.
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