Priced Liquidity Risk Factors at the Oslo Stock Exchange

Abstract

We examine how liquidity risk influences stock returns at the Oslo Stock Exchange by investigating if differences between returns are related to liquidity, and how liquidity should be measured. A wide range of distinct liquidity measures is studied, and the measures which best express liquidity risk are combined to a multifactor model. We use a multi-perspective approach to select and compare measures, and perform Fama-MacBeth regressions to evaluate the performance of factor combinations. We find liquidity risk to be priced. Turnover is found to be the liquidity measure that best captures liquidity risk, and trade-based measures are found to be more important than order-based measures. Our multifactor model consisting of amortized spread, trading volume, turnover in shares and the market factor seem to perform better than the capital asset pricing model (CAPM) empirically, and can be used as an alternative to the CAPM for practical applications. Both common and non-common variances of measures are important to express liquidity risk, and we suggest that asset pricing models should include several liquidity measures.