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Asset Pricing with Liquidity Risk: A Replication and Out-of-Sample Tests with the Recent US and the Japanese Market Data

Author

Listed:
  • Kazumori, Eiichiro
  • Sharman, Raj
  • Takeda, Fumiko
  • Yu, Hong

Abstract

Acharya and Pedersen (2005, hereafter AP) develop the liquidity-adjusted CAPM (LCAPM) that assets with higher illiquidity costs, higher liquidity risk, and higher market risk have higher average rates of return. Our paper conducts an independent replication and two out-of-sample tests with three datasets (US 1964 to 1999, US 2000 to 2016, and Japan 1978 to 2012), six versions of the LCAPM, and eight test portfolios. We first consider the “one-variable LCAPM test†for the intercept, the illiquidity cost effect, and the net liquidity risk effect. We then consider the “two-variable LCAPM test†that further requires that the market risk premium and the net liquidity risk premium are identical as implied by the AP theory. The LCAPM satisfies the one-variable test in 36.0% of regressions and the two-variable test in 5.2% of regressions conducted using the US data. This result is qualitatively similar across US samples and is consistent with the findings of an independent study by Holden and Nam (2018). The LCAPM does not satisfy either of the two tests in the Japanese market.

Suggested Citation

  • Kazumori, Eiichiro & Sharman, Raj & Takeda, Fumiko & Yu, Hong, 2019. "Asset Pricing with Liquidity Risk: A Replication and Out-of-Sample Tests with the Recent US and the Japanese Market Data," Critical Finance Review, now publishers, vol. 8(1-2), pages 73-110, December.
    • Handle: RePEc:now:jnlcfr:104.00000072
    DOI: 10.1561/104.00000072
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    Citations

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    Cited by:

    1. Rapheedah Musneh & Mohd. Rahimie Abdul Karim & Caroline Geetha A/P Arokiadasan Baburaw, 2021. "Liquidity risk and stock returns: empirical evidence from industrial products and services sector in Bursa Malaysia," Future Business Journal, Springer, vol. 7(1), pages 1-10, December.
    2. Ayad Assoil & Ndéné Ka & Jules Sadefo-Kamdem, 2021. "Analysis of the dynamic relationship between liquidity proxies and returns on the French CAC 40 index," SN Business & Economics, Springer, vol. 1(10), pages 1-23, October.
    3. Acharya, Viral V. & Pedersen, Lasse Heje, 2019. "Economics with Market Liquidity Risk," Critical Finance Review, now publishers, vol. 8(1-2), pages 111-125, December.
    4. Amihud, Yakov & Noh, Joonki, 2021. "The pricing of the illiquidity factor’s conditional risk with time-varying premium," Journal of Financial Markets, Elsevier, vol. 56(C).

    More about this item

    Keywords

    Liquidity; Asset pricing; Replication; Out-of-sample test;
    All these keywords.

    JEL classification:

    • G0 - Financial Economics - - General
    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • N20 - Economic History - - Financial Markets and Institutions - - - General, International, or Comparative

    Lists

    This item is featured on the following reading lists, Wikipedia, or ReplicationWiki pages:
    1. Asset Pricing with Liquidity Risk: A Replication and Out-of-Sample Tests with the Recent US and the Japanese Market Data (Critical Finance Review forthcoming) in ReplicationWiki

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