Asset market equilibrium with liquidity risk

Robert Jarrow ()

Annals of Finance, 2018, vol. 14, issue 2, No 5, 253-288

Abstract: Abstract This paper derives an equilibrium asset pricing model with endogenous liquidity risk. Liquidity risk is modeled as a stochastic quantity impact on the price from trading, where the size of the impact depends on trade size. Under a strong set of assumptions, we prove that a unique equilibrium liquidity cost process and a unique equilibrium price process exists for our economy. We characterize the market’s state price density, which enables the derivation of the risk-return relation for the stock’s expected return including liquidity risk. We derive a generalized intertemporal CAPM and consumption CAPM for these markets. In contrast to the traditional models without liquidity risk, there is an additional systematic liquidity risk factor which is related to the stock return’s covariation with the market’s stochastic liquidity cost. Traditional transaction costs are a special case of our formulation.

Keywords: Liquidity risk; Asset market equilibrium; Systematic risk; Intertemporal CAPM; Consumption CAPM (search for similar items in EconPapers)
JEL-codes: D53 G11 G12 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://link.springer.com/10.1007/s10436-017-0316-x Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:annfin:v:14:y:2018:i:2:d:10.1007_s10436-017-0316-x

Ordering information: This journal article can be ordered from
http://www.springer.com/finance/journal/10436/PS2

DOI: 10.1007/s10436-017-0316-x

Access Statistics for this article

Annals of Finance is currently edited by Anne Villamil

More articles in Annals of Finance from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().