Time-Varying Liquidity Risk and the Cross Section of Stock Returns

This paper studies whether stock returns' sensitivities to aggregate liquidity fluctuations and the pricing of liquidity risk vary over time. We find that liquidity betas vary across two distinct states, one with high liquidity betas and the other with low betas. The high liquidity beta state is short lived, and is associated with heavy trade, high volatility, and a wide crosssectional dispersion in liquidity betas. The liquidity risk premium also changes over time and is delivered primarily in the high liquidity-beta state. The conditional liquidity risk premium is statistically significant and economically large, rendering more than twice the value premium