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Asset Prices and asset Correlations in Illiquid Markets

Celso Brunetti and Alessio Caldarera
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Alessio Caldarera: BPN Paribas

No 331, Computing in Economics and Finance 2006 from Society for Computational Economics

Abstract: We build a new asset pricing framework to study the effects of aggregate illiquidity on asset prices, volatilities and correlations. In our framework the Black-Scholes economy is obtained as the limiting case of perfectly liquid markets. The model is consistent with empirical studies on the effects of illiquidity on asset returns, volatilities and correlations. We present the model, study its qualitative properties and estimate stocks' sensitivities to aggregate liquidity ($\beta$s) using nine years data for 24 randomly sampled stocks traded on the NYSE. These sensitivity parameters ($\beta$s) determine the effect that aggregate illiquidity has on expected returns, volatilities, correlations, CAPM-betas and Sharpe ratios. We find clear capitalization and sector patterns for liquidity $\beta$s.

Keywords: Market Liquidity; Volatilities; Correlations; Asset Pricing; GMM (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2006-07-04
New Economics Papers: this item is included in nep-cfn, nep-fin, nep-fmk and nep-rmg
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Citations: View citations in EconPapers (12)

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http://repec.org/sce2006/up.21727.1141097676.pdf (application/pdf)

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Working Paper: Asset Prices and Asset Correlations in Illiquid Markets (2005) Downloads
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