Further tests of asset pricing models: Liquidity risk matters

Ma, Xiuli; Zhang, Xindong; Liu, Weimin

Abstract

The recent asset pricing literature has largely neglected liquidity risk since the price-impact-based factor shows limited pricing ability. Using different liquidity factors, this paper evaluates the liquidity-risk-based models together with the non-liquidity-based ones. With the new testing procedures and the different testing portfolios, we find that the liquidity-augmented capital asset pricing model (LCAPM) performs well. It yields a significant liquidity risk premium robust to all the other models. The success of the LCAPM lies in the fact that the trading-discontinuity-based factor captures the systematic nature of liquidity risk. It shows that liquidity risk is priced highly during the down and turmoil markets, whereas all the other factors examined exhibit insignificant risk prices when market volatility is high. Our evidence indicates that liquidity risk matters and the LCAPM is preferable to use for investment decision making, financial market research and regulation.

Citation

Ma, X., Zhang, X., & Liu, W. (2021). Further tests of asset pricing models: Liquidity risk matters. Economic Modelling, 95, 255-273. https://doi.org/10.1016/j.econmod.2020.12.013

• Journal Article Type: Article
• Acceptance Date: Dec 15, 2020
• Online Publication Date: Dec 30, 2020
• Publication Date: 2021-02
• Deposit Date: Jan 20, 2022
• Publicly Available Date: Jan 21, 2022
• Journal: Economic Modelling
• Print ISSN: 0264-9993
• Electronic ISSN: 1873-6122
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 95
• Pages: 255-273
• DOI: https://doi.org/10.1016/j.econmod.2020.12.013
• Keywords: Liquidity risk; Asset pricing models; Model performance
• Public URL: https://nottingham-repository.worktribe.com/output/7281645
• Publisher URL: https://www.sciencedirect.com/science/article/pii/S0264999320312785
• Additional Information: This article is maintained by: Elsevier; Article Title: Further tests of asset pricing models: Liquidity risk matters; Journal Title: Economic Modelling; CrossRef DOI link to publisher maintained version: https://doi.org/10.1016/j.econmod.2020.12.013; Content Type: article; Copyright: © 2020 Elsevier B.V. All rights reserved.