Critical Finance Review > Vol 8 > Issue 1-2

Liquidity Risk and Asset Pricing

Hongtao Li, Guggenheim Partners, USA, , Robert Novy-Marx, University of Rochester, USA, , Mihail Velikov, Federal Reserve Bank of Richmond, USA,
Suggested Citation
Hongtao Li, Robert Novy-Marx and Mihail Velikov (2019), "Liquidity Risk and Asset Pricing", Critical Finance Review: Vol. 8: No. 1-2, pp 223-255.

Publication Date: 17 Dec 2019
© 2019 Hongtao Li, Robert Novy-Marx, and Mihail Velikov
JEL codes: G11G12
Asset pricingLiquidityFactor modelsMomentum


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In this article:
1. Introduction 
2. Replicating the Time-Series of Aggregate Liquidity 
3. Tradable Liquidity Risk Factors 
4. Predicted Liquidity Risk 
5. Conclusion 
Appendix: Additional Tables 


Pastor and Stambaugh’s (PS 2003) aggregate liquidity innovations can be closely replicated, as can their traded factor based on historically estimated liquidity betas, which performs even stronger out of sample. This factor’s performance is highly sensitive to construction details, however, and exhibits significantly weaker performance when rebalanced at its natural monthly frequency, or when constructed using either more or less extreme sorts. Their predicted liquidity risk factor is more difficult to replicate, and difficult to interpret because characteristics chosen to predict liquidity risk introduce mechanical relations to other known anomalies. Contrary to the claims of PS, liquidity risk appears essentially unrelated to momentum.