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Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2006/9:
Pricing Implications of Shared Variance in Liquidity Measures

Lorįn Chollete (), Randi Nęs () and Johannes A. Skjeltorp ()

Abstract: Is the effect of liquidity risk on asset prices sensitive to our choice of liquidity proxy? In addressing this fundamental question, we achieve two main results. First, when we estimate factor models on a broad range of liquidity measures we uncover a profound distinction between trade and order based liquidity. Second, although the order based factor provides a better signal of available liquidity, we find that only the factor related to information risk explains expected returns both in a theoretical liquidity-CAPM model and in a linear pricing framework. Our results suggest a surprising fragility of liquidity-based asset pricing.

Keywords: CAPM; Liquidity Risk; Liquidity Factor; Order Based Measure; Trade Based Measure; Information Risk; (follow links to similar papers)

JEL-Codes: G12; G14; (follow links to similar papers)

41 pages, August 4, 2006, Revised June 21, 2007

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