The pricing of illiquidity and illiquid assets:Essays on empirical asset pricing

This dissertation studies the pricing of liquidity and illiquid assets. For this thesis, liquidity will generally refer to the ease with which an asset can be traded. The first chapter investigates the role of the investment horizon in the impact of illiquidity on stock prices. We obtain a clientele effect where short-term investors choose not to invest in the least liquid assets, as their expected returns are not sufficient to cover expected transaction costs. The least liquid assets are held by less liquidity-sensitive long-term investors. This feature allows us to better explain the cross-section of U.S. stock returns than a single-horizon model. The second chapter studies the pricing of house-specific risk for U.S. residential real estate. We show that house-specific risk is priced and we show that the extent to which it is priced increases with a proxy for the degree of underdiversification. The third chapter studies the impact of time-variation in liquidity on stock prices. It distinguishes between an overall deterioration in liquidity and a situation where only the least liquid assets become even less liquid. The results show that only the risk of an overall deterioration in liquidity is relevant for U.S. stock prices

Pricing Liquidity Risk with Heterogeneous Investment Horizons

We develop a new asset pricing model with stochastic transaction costs and investors with heterogenous horizons. Short-term investors hold only liquid assets in equilibrium. This generates segmentation effects in the pricing of liquid versus illiquid assets. Specifically, the liquidity (risk) premia of illiquid assets are determined by the heterogeneity in investor horizons and by the correlation between liquid and illiquid assets. We estimate our model for the cross-section of U.S. stocks and find that it fits average returns substantially better than a standard liquidity CAPM. Allowing for heterogenous horizons also leads to much larger estimates for the liquidity premia

The pricing of illiquidity and illiquid assets: Essays on empirical asset pricing

This dissertation studies the pricing of liquidity and illiquid assets. For this thesis, liquidity will generally refer to the ease with which an asset can be traded. The first chapter investigates the role of the investment horizon in the impact of illiquidity on stock prices. We obtain a clientele effect where short-term investors choose not to invest in the least liquid assets, as their expected returns are not sufficient to cover expected transaction costs. The least liquid assets are held by less liquidity-sensitive long-term investors. This feature allows us to better explain the cross-section of U.S. stock returns than a single-horizon model. The second chapter studies the pricing of house-specific risk for U.S. residential real estate. We show that house-specific risk is priced and we show that the extent to which it is priced increases with a proxy for the degree of underdiversification. The third chapter studies the impact of time-variation in liquidity on stock prices. It distinguishes between an overall deterioration in liquidity and a situation where only the least liquid assets become even less liquid. The results show that only the risk of an overall deterioration in liquidity is relevant for U.S. stock prices

Pricing Liquidity Risk with Heterogeneous Investment Horizons

We develop a liquidity-based asset pricing model featuring investors with heterogeneous investment horizons and stochastic transaction costs. In an equilibrium where all investors invest in all assets (integration), we find that the existence of investors with heterogeneous horizons, as opposed to homogeneous horizons, reduces the importance of liquidity risk relative to the standard CAPM market risk and generates a more complex effect of expected liquidity. In an equilibrium where short-term investors do not invest in some more illiquid assets (partial segmentation), our model generates an additional segmentation premium for these assets. We estimate the model for the cross-section of U.S. stocks using GMM and find that our heterogeneous-horizon asset pricing model fares better than a standard liquidity-adjusted CAPM. The segmented version of our model delivers the best cross-sectional fit and generates a substantial effect of expected liquidity on expected returns.investment horizon; liquidity risk

Pricing liquidity risk with heterogeneous investment horizons

We develop an asset pricing model with stochastic transaction costs and investors with heterogeneous horizons. Depending on their horizon, investors hold different sets of assets in equilibrium. This generates segmentation and spillover effects for expected returns, where the liquidity (risk) premium of illiquid assets is determined by investor horizons and the correlation between liquid and illiquid asset returns. We estimate our model for the cross-section of U.S. stock returns and find that it generates a good fit, mainly due to a combination of a substantial expected liquidity premium and segmentation effects, while the liquidity risk premium is small