Liquidity and Liquidity Risk in the Cross-Section of Stock Returns

Abstract

This paper examines the relative importance of liquidity level and liquidity risk for the cross-section of stock returns. A portfolio analysis is implemented to make inferences about the pricing ability of liquidity as a characteristic or as a risk. I find that the ratio of absolute returns-to-volume, the Amihud liquidity measure, is able to explain more variance in stock returns than a battery of liquidity risk measures. My results suggest that trading cost and frictions impact financial markets more than the systemic components of liquidity.