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Jegadeesh, Narasimhan, and Sheridan Titman

 Jegadeesh, Narasimhan, and Sheridan Titman Analysis Paper

Fluid Risk and Expected Share Returns

Л‡

Lubos Pa

Л‡ Вґstor

University of Chicago, National Bureau of Economic Study, and Center for Economical Policy Analysis

Robert F Stambaugh

.

School of Pennsylvania and Nationwide Bureau of Economic Research

This research investigates whether marketwide fluid is a condition variable necessary for asset charges. We find that expected stock results are related cross-sectionally to the sensitivities of returns to fluctuations in aggregate fluid. Our month-to-month liquidity measure, an average of individual-stock measures believed with daily data, relies upon the basic principle that order flow induce greater go back reversals when ever liquidity is lower. From 1966 through 1999, the average return on stocks and shares with substantial sensitivities to liquidity exceeds that pertaining to stocks with low breathing difficulties by several. 5 percent every year, adjusted for exposures towards the market come back as well as size, value, and momentum factors. Furthermore, a liquidity risk factor accounts for half of the profits to a impetus strategy over the same 34-year period.

Analysis support through the Center to get Research in Security Prices and the Wayne S. Kemper Faculty Study Fund at the Graduate College of Business, University of Chicago, is definitely gratefully known (Pastor). Our company is grateful to get comments coming from Nick Barberis, Вґ

Steve Campbell, Tarun Chordia, John Cochrane (the editor), George Constantinides, Doug Diamond, Andrea Eisfeldt, Gene Fama, Claire Gervais, David Goldreich, Gur Huberman, Jordan Johannes, Owen Lamont, Andrew Metrick, Draw Ready, Hans Stoll, Dick Thaler, Take advantage of Vishny, Tuomo Vuolteenaho, Jiang Wang, and two private referees, along with workshop individuals at Columbia University, Harvard University, New york city University, Stanford University, University or college of Arizona, University of California in Berkeley, School of Chi town, University of Florida, University of Philadelphia, Washington School, the Review of Economical Studies Meeting on Investments in Imperfect Capital Markets in Northwestern School, the Fall season 2001 NBER Asset Charges meeting, and the 2002 Traditional western Finance Relationship meetings.

[Journal of Political Overall economy, 2003, vol. 111, no . 3]

б­§ the year 2003 by The University of Chi town. All rights reserved. 0022-3808/2003/11103-0006$10. 00

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liquidity risk

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643

Introduction

In standard asset pricing theory, expected stock returns happen to be related crosssectionally to returns' sensitivities to mention variables with pervasive effects on investors' overall well being. A security in whose lowest earnings tend to go along with unfavorable adjustments in that welfare must give additional reimbursement to investors for possessing the security. Liquidity appears to be an excellent candidate for a priced point out variable. It is viewed as a significant feature in the investment environment and macroeconomy, and recent research find that fluctuations in several measures of liquidity will be correlated throughout assets. you This scientific study investigates whether marketwide liquidity is indeed priced. That is, we question whether crosssectional differences in expected stock results are related to the sensitivities of earnings to fluctuations in get worse liquidity. It seems like reasonable that many investors might require higher anticipated returns in assets in whose returns include higher breathing difficulties to aggregate liquidity. Consider, for example , any kind of investor whom employs some form of leverage and faces a margin or solvency restriction, in that in the event his overall wealth drops sufficiently, he or she must liquidate a few assets to raise cash. If perhaps he keeps assets with higher breathing difficulties to liquidity, then these kinds of liquidations may occur the moment liquidity is definitely low, seeing that drops in his overall prosperity are then simply more likely to accompany drops in liquidity. Liquidation is more expensive when fluidity is lower, and the ones greater costs are especially unwanted to an buyer whose wealth has already decreased and who thus provides higher minor utility of wealth. Until the trader expects...

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