Liquidity is the ease of trading a security. There are many sources of illiquidity that add costs to an asset, including exogenous transaction costs, search friction, demand pressure and inventory risk. These costs of illiquidity should affect securities prices. Investors need to know them in designing their investment strategies. If liquidity costs and risks affect the required return by investors, then they affect corporations’ cost of capital and, hence, the allocation of the economy's real resources.

Liquidity has wide-ranging effects on financial markets. Liquidity and Asset Prices shows that liquidity can help explain the cross-section of assets with different liquidity, after controlling for other assets’ characteristics such as risk, and the time series relationship between liquidity and securities returns. Liquidity helps explain why certain hard-to-trade securities are relatively cheap, the pricing of stocks and corporate bonds, the return on hedge funds, and the valuation of closed-end funds. It follows that liquidity can help explain a number of puzzles, such as the equity premium puzzle and why liquid risk-free treasuries have low required returns — the risk-free rate puzzle.

Liquidity and Asset Prices surveys the theory of liquidity-based asset pricing followed by the empirical evidence. The theory section proceeds from basic models with exogenous holding periods to those that incorporate additional elements of risk and endogenous holding periods. The empirical section reviews the evidence on the liquidity premium for stocks, bonds, and other financial assets.

Published by Now Publishers and marketed by World Scientific

Contents:

• Introduction
• Theory
• Empirical Evidence
• References