Critical Finance Review > Vol 8 > Issue 1-2

Liquidity Risk and Asset Pricing

Hongtao Li, Guggenheim Partners, USA, hongtao.li@outlook.com Robert Novy-Marx, University of Rochester, USA, robert.novy-marx@simon.rochester.edu Mihail Velikov, Federal Reserve Bank of Richmond, USA, mihail.velikov@rich.frb.org
 
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 x-xx. http://dx.doi.org/10.1561/104.00000076

Forthcoming: 31 Oct 2019
© 2019 H. Li, R. Novy-Marx and M. Velikov
 
Subjects
 
Keywords
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
References

Abstract

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.

DOI:10.1561/104.00000076