Asset pricing anomalies: Liquidity risk hedgers or liquidity risk spreaders? |
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| Institution: | 1. University of Naples Parthenope, Department of Management Studies and Quantitative Methods, Via G. Parisi, 13, 80132 Napoli (NA), Italy;1. School of Business and Management, Queen Mary University of London, Mile End Road, London E1 4NS, UK;2. Huddersfield Business School University of Huddersfield Queensgate, Huddersfield HD1 3DH, UK;1. Alfaisal University, Saudi Arabia;2. University of Leicester, UK;3. University of Lincoln, UK;4. University of Manchester, UK;1. Department of Agricultural Economics, Texas A&M University, College Station. 344 AGLS Building, 2124 TAMU, College Station, TX 77843-2124, USA;2. Department of Finance and Insurance, FSA Business School, Université Laval, Quebec City, QC G1V 0A6, Canada |
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| Abstract: | We capture two distinct investing preferences – hedging against aggregate liquidity risk or betting on it – in the cross-section of stock returns. A three-factor model underpinned by exposures to changes in market liquidity, isolating two alternating patterns, is developed. Our results can be summarized in the following ways: one, the improved performance of recent asset-pricing models is driven by factors that mimic liquidity risk hedging and are linked to cross-sectional mispricing. Two, our model outperforms competing models in explaining time-series return variation across market states. Three, our parsimonious model enables an understanding of diverging return premia in the cross-section. Four, the estimated risk premiums in our model correspond to theoretical, economic, and statistical restrictions holistically across varied and complex anomaly structures. In this respect, the performance of the proposed model is even better than the risk premiums on factors in the model that have the largest cross-sectional r-squared values. |
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