The pricing of systematic liquidity risk: Empirical evidence from the US stock market

In this study, we examine whether aggregate market liquidity risk is priced in the US stock market. We define a bivariate Garch (l,1)-in-mean specification for the market portfolio excess returns and the changes in the standardized number of shares in the S&P 500 Index, the aggregate market liquidity proxy. The findings, based on monthly data, suggest that systematic liquidity risk is priced in the US over the period January 1973-December 1997. The liquidity premium represents a non-negligible, negative and time-varying component of the total market risk premium whose magnitude is not influenced by the October'87 Crash. (C) 2002 Elsevier B.V. All rights reserved.