This study investigates whether marketwide liquidity is a state variable important for asset pricing. We find that expected stock returns are related cross-sectionally to the sensitivities of returns to fluctuations in aggregate liquidity. Our monthly liquidity measure, an average of individual-stock measures estimated with daily data, relies on the principle that order flow induces greater return reversals when liquidity is lower. From 1966 through 1999, the average return on stocks with high sensitivities to liquidity exceeds that for stocks with low sensitivities by 7.5 percent annually, adjusted for exposures to the market return as well as size, value, and momentum factors. Furthermore, a liquidity risk factor accounts for half of the profits to a momentum strategy over the same 34-year period.

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Liquidity Risk and Expected Stock Returns

Do liquidity measures measure liquidity

Motivated from investment-based asset pricing, we propose a new factor model that consists of the market factor, a size factor, an investment factor, and a return-on-equity factor The new model [i] outperforms the Carhart (1997) four-factor model in pricing portfolios formed on earnings surprise, idiosyncratic volatility, financial distress, equity issues, as well as on investment and return-on-equity; [ii] performs similarly as the Carhart model in pricing portfolios on momentum as well as on size and book-to-market; but [iii] underperforms in pricing the total accrual deciles Our model's performance, combined with its clear economic intuition, suggests that it can serve as a new workhorse model for academic research and investment management practice

Digesting Anomalies: An Investment Approach

This paper solves explicitly a simple equilibrium model with liquidity risk. In our liquidityadjusted capital asset pricing model, a security s required return depends on its expected liquidity as well as on the covariances of its own return and liquidity with the market return and liquidity. In addition, a persistent negative shock to a security s liquidity results in low contemporaneous returns and high predicted future returns. The model provides a unified framework for understanding the various channels through which liquidity risk may affect asset prices. Our empirical results shed light on the total and relative economic significance of these channels and provide evidence of flight to liquidity. r 2005 Elsevier B.V. All rights reserved.

Market Liquidity: Asset Pricing with Liquidity Risk

Using a large hand-collected dataset from 2001 to 2006, we find that activist hedge funds in the U.S. propose strategic, operational, and financial remedies and attain success or partial success in two thirds of the cases. Hedge funds seldom seek control and in most cases are nonconfrontational. The abnormal return around the announcement of activism is approximately 7%, with no reversal during the subsequent year. Target firms experience increases in payout, operating performance, and higher CEO turnover after activism. Our analysis provides important new evidence on the mechanisms and effects of informed shareholder monitoring.

Hedge Fund Activism, Corporate Governance, and Firm Performance

New tests are presented on the effects of stock illiquidity on stock return. Over time, expected market illiquidity positively affects ex ante stock excess return (usually called â¬Srisk premiumâ¬?). This complements the positive cross-sectional return-illiquidity relationship. The illiquidity measure here is the average daily ratio of absolute stock return to dollar volume, which is easily obtained from daily stock data for long time series in most stock markets. Illiquidity affects more strongly small firms stocks, suggesting an explanation for the changes â¬Ssmall firm effectâ¬? over time. The impact of market illiquidity on stock excess return suggests the existence of illiquidity premium and helps explain the equity premium puzzle.

Yakov Amihud

Papers

Market Liquidity: Illiquidity and Stock Returns Cross-Section and Time-Series Effects＊