pastor - Liquidity Risk and Expected Stock Returns by* Lubo...

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Liquidity Risk and Expected Stock Returns by * · Lubo· sP¶astor and Robert F. Stambaugh First draft: July 13, 2001 This revision: July 11, 2002 Abstract This study investigates whether market-wide liquidity is a state variable important for asset pricing. We ¯nd that expected stock returns are related cross-sectionally to the sensitivities of returns to °uctuations in aggregate liquidity. Our monthly liquidity measure, an average of individual-stock measures estimated with daily data, relies on the principle that order °ow induces greater return reversals when liquidity is lower. Overa34-yearper iod ,theaveragereturnonstocksw ithh ighsens it iv iestol iqu id ity exceeds that for stocks with low sensitivities by 7.5% annually, adjusted for exposures to the market return as well as size, value, and momentum factors. JEL Classi¯cation: G12 Keywords: asset pricing, liquidity risk, expected returns * Graduate School of Business, University of Chicago, NBER, and CEPR (P¶ astor) and the Wharton School, University of Pennsylvania and NBER (Stambaugh). Research support from the Center for Research in Security Prices and the James S. Kemper Faculty Research Fund at the Graduate School of Business, University of Chicago is gratefully acknowledged (P¶ astor). We are grateful for comments from Nick Barberis, John Campbell, Tarun Chordia, John Cochrane (the editor), George Constantinides, Doug Diamond, Andrea Eisfeldt, Gene Fama, Simon Gervais, David Goldreich, Gur Huberman, Michael Johannes, Owen Lamont, Andrew Metrick, Mark Ready, Hans Stoll, Dick Thaler, Rob Vishny, Tuomo Vuolteenaho, Jiang Wang, and two anonymous referees, as well as workshop participants at Columbia University, Harvard University, New York University, Stanford University, University of Arizona, University of California at Berkeley, University of Chicago, University of Florida, University of Pennsylvania, Washington University, the RFS Conference on Investments in Imperfect Capital Markets at Northwestern University, the Fall 2001 NBER Asset Pricing meeting, and the 2002 Western Finance Association Meetings.
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I. Introduction In standard asset pricing theory, expected stock returns are related cross-sectionally to re- turns' sensitivities to state variables with pervasive e®ects on investors' overall welfare. A security whose lowest returns tend to accompany unfavorable shifts in that welfare must o®er additional compensation to investors for holding the security. Liquidity appears to be a good candidate for a priced state variable. It is often viewed as an important feature of the investment environment and macroeconomy, and recent studies ¯nd that °uctuations in various measures of liquidity are correlated across assets. 1 This empirical study investigates whether market-wide liquidity is indeed priced. That is, we ask whether cross-sectional dif- ferences in expected stock returns are related to the sensitivities of returns to °uctuations in aggregate liquidity.
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This note was uploaded on 12/08/2011 for the course CIS 625 taught by Professor Michaelkearns during the Spring '12 term at Pennsylvania State University, University Park.

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pastor - Liquidity Risk and Expected Stock Returns by* Lubo...

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