An earnings,liquidity, and market model

We combine the market with earnings, liquidity and their respective growth, with motivation via a simple pricing equation, to model the cross-section with three, four and five factors. As first-order variables in widespread investor use for over a hundred years, earnings and liquidity have ready connection to investor preferences. They obtain as good a cross-sectional description of security prices as other factor models without redundancy. We weight portfolios on volume, relying on a direct SDF representation of investor’s preference for liquidity, demonstrating its additional dimension. Recent research arguing for the demise of liquidity is premature; indeed, its importance has grown.