Stock and Bond Liquidity and its Effect on Prices and Financial Policies |
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| Authors: | Yakov Amihud Haim Mendelson |
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| Affiliation: | (1) Ira Leon Rennert professor of Entrepreneurial Finance, Leonard N. Stern Graduate School of Business, New York University, New York, USA;(2) The Kleiner, Perkins, Caufield & Byers Professor of Electronic Business and Commerce, and Management,Graduate School of Business, Stanford University, Stanford, CA 94305, USA |
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| Abstract: | An asset is liquid if it can be traded at the prevailing market price quickly and at low cost. We show that in addition to risk, liquidity affects asset prices and returns. Theories of asset pricing suggest that the expected return of an asset is increasing in its risk, because risk-averse investors require compensation for bearing more risk. Because investors are also averse to the costs of illiquidity and want to be compensated for bearing them, asset returns are increasing in illiquidity. Thus, asset prices should depend on two asset characteristics: risk and liquidity. This paper surveys research on the effects of liquidity on asset prices and returns, showing that liquidity is an important factor in capital asset pricing. |
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| Keywords: | Market efficiency Liquidity risk premia Asset prices |
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