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Funding liquidity risk and the cross-section of stock returns


Abstract: We derive equilibrium pricing implications from an intertemporal capital asset pricing model where the tightness of financial intermediaries? funding constraints enters the pricing kernel. We test the resulting factor model in the cross-section of stock returns. Our empirical results show that stocks that hedge against adverse shocks to funding liquidity earn lower average returns. The pricing performance of our three-factor model is surprisingly strong across specifications and test assets, including portfolios sorted by industry, size, book-to-market, momentum, and long-term reversal. Funding liquidity can thus account for well-known asset pricing anomalies.

Keywords: Capital assets pricing model; Intermediation (Finance); Stocks - Rate of return; Assets (Accounting); Liquidity (Economics);

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2010

Number: 464