Abstract
Is the effect of liquidity risk on asset prices sensitive to the choice of liquidity proxy? In our study we achieve three main results. First, we extract three factors from a broad range of trade- and order based liquidity variables, and find that an order based liquidity factor is not related to realized returns while a trade based liquidity factor tied to information risk is. Second, we find evidence that the factor related to information risk explains expected returns when we estimate the theoretical liquidity-adjusted CAPM. Third, when we estimate a liquidity-augmented factor model, the Fama-French model does well in pricing stocks relative to each individual liquidity factor, but a CAPM model augmented with all our liquidity factors outraces the Fama-French model.
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