NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Liquidity Risk and Expected Stock Returns

Lubos Pastor, Robert F. Stambaugh

NBER Working Paper No. 8462
Issued in September 2001
NBER Program(s):   AP

This study investigates whether market-wide liquidity is a state variable important for asset pricing. We find that expected stock returns are related cross-sectionally to the sensitivities of returns to fluctuations in aggregate liquidity. Our monthly liquidity measure, an average of individual-stock measures estimated with daily data, relies on the principle that order flow induces greater return reversals when liquidity is lower. Over a 34-year period, the average return on stocks with high sensitivities to liquidity exceeds that for stocks with low sensitivities by 7.5% annually, adjusted for exposures to the market return as well as size, value, and momentum factors.

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Published: Pastor, Lubos and Robert F. Stambaugh. "Liquidity Risk And Expected Stock Returns," Journal of Political Economy, 2003, v111(3,Jun), 642-685.

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