Asset Liquidity and the Cost of Capital

Hernán Ortiz-Molina, Gordon M. Phillips

NBER Working Paper No. 15992
Issued in May 2010
NBER Program(s):   AP   CF

We study the effect of real asset liquidity on a firm's cost of capital. We find an aggregate asset-liquidity discount in firms' cost of capital that is strongly counter-cyclical. At the firm-level we find that asset liquidity affects firms' cost of capital both in the cross section and in the time series: Firms in industries with more liquid assets and during periods of high asset liquidity have lower cost of capital. This effect is stronger when the asset liquidity is provided by firms operating within the industry. We also find that higher asset liquidity reduces the cost of capital by more for firms that face more competitive risk in product markets, have less access to external capital or are closer to default, and for those facing negative demand shocks. Our results suggest that asset liquidity is valuable to firms and, more generally, that operating inflexibility is an economically important source of risk.

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Document Object Identifier (DOI): 10.3386/w15992

Published: Real Asset Illiquidity and the Cost of Capital Hernán Ortiz-Molinaa1 and Gordon M. Phillips Journal of Financial and Quantitative Analysis / Volume 49 / Issue 01 / February 2014, pp 1-32

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