A liquidity-augmented capital asset pricing model |
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Authors: | Weimin Liu |
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Institution: | Manchester Business School, The University of Manchester, Manchester M15 6PB, UK |
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Abstract: | Using a new measure of liquidity, this paper documents a significant liquidity premium robust to the CAPM and the Fama–French three-factor model and shows that liquidity is an important source of priced risk. A two-factor (market and liquidity) model well explains the cross-section of stock returns, describing the liquidity premium, subsuming documented anomalies associated with size, long-term contrarian investment, and fundamental (cashflow, earnings, and dividend) to price ratios. In particular, the two-factor model accounts for the book-to-market effect, which the Fama–French three-factor model fails to explain. |
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Keywords: | G12 G14 |
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