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Pricing Liquidity Risk with Heterogeneous Investment Horizons

Published online by Cambridge University Press:  03 April 2020

Alessandro Beber ,
Joost Driessen Open the ORCID record for Joost Driessen [Opens in a new window] ,
Anthony Neuberger  and
Patrick Tuijp Open the ORCID record for Patrick Tuijp [Opens in a new window]
Alessandro Beber
Affiliation:
Beber, Alessandro.Beber@gmail.com, BlackRock and Center for Economic and Policy Research (CEPR)
Joost Driessen*
Affiliation:
Driessen, j.j.a.g.driessen@uvt.nl, Tilburg University
Anthony Neuberger
Affiliation:
Neuberger, Anthony.Neuberger.1@city.ac.uk, Cass Business School, City, University of London
Patrick Tuijp
Affiliation:
Tuijp, Patrick.Tuijp@ortec-finance.com, Ortec Finance and University of Amsterdam
*
Driessen (corresponding author), j.j.a.g.driessen@uvt.nl
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Abstract

We develop an asset pricing model with stochastic transaction costs and investors with heterogeneous horizons. Depending on their horizon, investors hold different sets of assets in equilibrium. This generates segmentation and spillover effects for expected returns, where the liquidity (risk) premium of illiquid assets is determined by investor horizons and the correlation between liquid and illiquid asset returns. We estimate our model for the cross-section of U.S. stock returns and find that it generates a good fit, mainly due to a combination of a substantial expected liquidity premium and segmentation effects, while the liquidity risk premium is small.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 56 , Issue 2 , March 2021 , pp. 373 - 408
Copyright
© Michael G. Foster School of Business, University of Washington 2020

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Footnotes

We thank Frank de Jong, Bart Diris, Darrell Duffie, Pete Kyle, Marco Pagano, Richard Payne, Ken Singleton, and Dimitri Vayanos; seminar participants at University of Essex (2011), University of Maryland (2011), University of North Carolina (2011), Tilburg University (2012), the 2011 Center for Studies in Economics and Finance and Innocenzo Gasparini Institute for Economic Research (CSEF-IGIER) Symposium on Economics and Institutions, the 2013 European Finance Association (EFA) Conference, the Duisenberg School of Finance (2012), the Financial Risks International Forum (2013), the 2011 Erasmus Liquidity Conference, the 2012 Tinbergen Institute Conference (joint with Society for Financial Econometrics (SoFiE)), and the 2012 Western Finance Association (WFA) conference; and Jack Bao (the referee and also the WFA 2012 discussant) and Jennifer Conrad (the editor) for very useful comments.

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