The Epstein–Zin Model with Liquidity Extension |
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Authors: | Weimin Liu Di Luo Huainan Zhao |
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Institution: | 1. Nottingham University Business School China and Shanxi University;2. Swansea University;3. Cranfield University School of Management |
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Abstract: | In this paper, we extend the Epstein–Zin model with liquidity risk and assess the extended model's performance against the traditional consumption pricing models. We show that liquidity is a significant risk factor, and it adds considerable explanatory power to the model. The liquidity‐extended model produces both a higher cross‐sectional R2 and a smaller Hansen and Jagannathan distance than the traditional consumption‐based capital‐asset pricing model and the original Epstein–Zin model. Overall, we show that liquidity is both a priced factor and a key contributor to the extended Epstein–Zin model's goodness‐of‐fit. |
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Keywords: | liquidity risk consumption‐based asset pricing model performance G12 G14 |
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