Understanding Fair Value During Liquidity and Credit Crises - Pricing of Corporate Liquidity Risk

Financial crisis of year 2008 suggests that the existing asset pricing models, which are derived under the assumption of investor's rationality, are not enough to explain the stock performance during market stress and liquidity crunch periods. In this paper, we created four measures of corporate liquidity risk factors and examined the dynamic impact of these risk factors on stock returns, especially during market stress and liquidity crunch periods. We found out that corporate liquidity risks played a significant role in affecting stock returns, especially during the period when market is stressed or liquidity crunched. We also investigate whether the corporate liquidity risk loadings will stayed the same for stocks with different attributes. We believe our analysis significant insights to investors who wish to better understand the impact of risk factors in a more time-sensitive way. In addition, our research about corporate liquidity risk factor loadings for stocks with different attributes will also generate interest to investors as this will help them to better understand how corporate liquidity risk factor is priced in cross-sectionally and thus can better position themselves in terms of their investments