Liquidity Discovery and Asset Pricing

Duane Seppi, Michael F. Gallmeyer () and Burton Hollifield ()

No 525, Econometric Society 2004 North American Summer Meetings from Econometric Society

Abstract: Most investors purchase securities knowing they will resell those securities in the future. Uncertainty about the preferences of future trading counter-parties causes randomness in future resale prices that we call liquidity risk. It is natural to suppose that investors are asymmetrically informed about liquidity risk. Through a process of liquidity discovery, trading volumes and prices reveal private information about future counter-party preferences. The liquidity discovery process leads to endogenous joint dynamics for prices, trading volume, volatility, and expected returns. In particular, market liquidity is a forward-looking predictor of future liquidity risk and, as such, is priced. Liquidity discovery provides an alternative explanation to transaction costs for the relationships between current market liquidity measures and future returns

Keywords: Liquidity; Asset Pricing (search for similar items in EconPapers)
JEL-codes: G12 G14 (search for similar items in EconPapers)
Date: 2004-08-11
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