Asset Pricing and Systematic Liquidity Risk: an Empirical Investigation of the Spanish Stock Market

It seems reasonable to expect systematic liquidity shocks to affect the optimal behavior of agents in financial markets. Indeed, fluctuations in various measures of liquidity are significantly correlated across common stocks(Chordia, Roll and Subrahmanyam (2000)). Thus, this paper empirically analyzes whether Spanish expected returns during the nineties are associated cross-sectionally to betas estimated relative to two competing liquidity risk factors. On one hand, we propose a new market-wide liquidity factor which is defined as the difference between returns of stocks highly sensitive to changes in the relative bid-ask spread less returns from stocks with low sensitivities to those changes. We argue that stocks with positive covariability between returns and this factor are assets whose returns tend to go down when aggregate liquidity is low, and hence do not hedge a potential liquidity crisis. Consequently, investors will require a premium to hold these assets. Similarly, note that in the case of assets that covary negatively with the liquidity factor, investors may be willing to pay a premium rather than to require an additional compensation. On the other hand, Pastor and Stambaugh (2002) suggest that a reasonable liquidity risk factor should be associated with the strength of volume-related return reversals since order flow induces greater return reversals when liquidity is lower. Our empirical results show that neither of these proxies for systematic liquidity risk carries a premium in the Spanish stock market. Miguel A. Martínez and Gonzalo Rubio acknowledge the financial support provided by Ministerio de Ciencia y Tecnología grant BEC2001-0636. Mikel Tapia acknowledge the financial support provided by Ministerio de Ciencia y Tecnología grant BEC2002-00279. 1. Departamento de Fundamentos del Análisis Económico. II Facultad de Ciencias Económicas y Empresariales. Universidad del País Vasco. Avda. del Lehendakari Aguirre 83 48015 Bilbao. Vizcaya. E-mail: [email protected] 2. Departamento de Economía Financiera, Contabilidad y Marketing. Carretera San Vicente del Raspeig, s/n, 03690 San Vicente del Raspeig. Alicante. E-mail: [email protected] 3. Departamento de Fundamentos del Análisis Económico. II Facultad de Ciencias Económicas y Empresariales. Universidad del País Vasco. Avda. del Lehendakari Aguirre 83. 48015 Bilbao, Vizcaya. E-mail: [email protected] 4. Departamento de Economía de la Empresa, Universidad Carlos III de Madrid. Calle Madrid, 126. 28903 Getafe Madrid. E-mail: [email protected] 1