Price delay premium and liquidity risk

Hou and Moskowitz (2005) document that common stocks with more price delay in reflecting information yield higher returns and that the delay premium cannot be explained by the CAPM, Fama-French three-factor model, or Carhart's four-factor model. It cannot be explained by conventional liquidity measures either. They contend that the premium is attributable to inadequate risk sharing arising from lack of investor recognition, as Merton (1987) suggests. Using a parsimonious and powerful asset pricing model developed by Liu (2006), we re-examine the issue and find that firms with greater price delay have more difficulty attracting traders (higher incidents of non-trading) and their investors face higher liquidity risk, which accounts for their anomalous returns. Our findings suggest that the price delay premium is due to systematic liquidity risk, not inadequate risk sharing.