Scandinavian Working Papers in Economics

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

No 2008/7: The Risk Components of Liquidity

Lorán Chollete (), Randi Næs () and Johannes A. Skjeltorp ()
Additional contact information
Lorán Chollete: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway
Randi Næs: Norges Bank, Postal: Norges Bank , Bankplassen 2 , P.O.Box 1179 Sentrum , 0107 Oslo , Norway
Johannes A. Skjeltorp: Norges Bank, Postal: Norges Bank , Bankplassen 2 , P.O.Box 1179 Sentrum , 0107 Oslo , Norway

Abstract: Does liquidity risk differ depending on our choice of liquidity proxy? Unlike literature that considers common liquidity variation, we focus on identifying different components of liquidity, statistically and economically, using more than a decade of US transaction data. We identify three main statistical liquidity factors which are utilized in a linear asset pricing framework. We motivate a correspondence of the statistical factors to traditional dimensions of liquidity as well as the notion of order and trade based liquidity measures. We find evidence of multiple liquidity risk premia, but only a subset of the financial liquidity factors are associated with significant risk premia. These are the factors that we relate to the dimensions of immediacy and resilliency, while the depth dimension does not command a risk premium in any of the models. Our results suggests caution when choosing liquidity variables in asset pricing applications, since liquidity premia may be reflected in only some dimensions of liquidity.

Keywords: Liquidity Risk; Liquidity Factors; Asset Pricing; Market Microstructure

JEL-codes: G12; G14

24 pages, March 12, 2008

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