Liquidity Might Come at Cost: The Role of Heterogeneous Preferences

56 Pages Posted: 21 Feb 2018 Last revised: 21 Mar 2018

See all articles by Shmuel Hauser

Shmuel Hauser

Ben-Gurion University of the Negev - School of Management; Government of the State of Israel - Israel Securities Authority

Haim Kedar-Levy

Ben Gurion University of the Negev - Guilford Glazer Faculty of Business and Management

Date Written: February 9, 2018

Abstract

Asset-pricing models with volume are challenged by the high turnover-rates in real stock markets. We develop an asset-pricing framework with heterogeneous risk preferences and show that liquidity and turnover increase with heterogeneity to a maximum, and then decline. With U.S. parameters, turnover exceeds 55%. Liquidity is costly since it facilitates a large share redistribution across agents, causing changes in average risk aversion, which increases Sharpe ratio variability, and hence stock return volatility. Illiquidity and its risk are minimized at moderate heterogeneity levels, highlighting an "optimal" heterogeneity level, yet, there is no "optimal" combination between liquidity level and Sharpe ratio variability.

Keywords: Heterogeneity, Discount Rate Risk, Turnover, Liquidity, Sharpe-Ratio

JEL Classification: C61, D53, E44, G11, G12

Suggested Citation

Hauser, Shmuel and Kedar-Levy, Haim, Liquidity Might Come at Cost: The Role of Heterogeneous Preferences (February 9, 2018). Journal of Financial Markets, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3121161

Shmuel Hauser

Ben-Gurion University of the Negev - School of Management ( email )

P.O. Box 653
Beer-Sheva 84105
Israel
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Government of the State of Israel - Israel Securities Authority

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Israel

Haim Kedar-Levy (Contact Author)

Ben Gurion University of the Negev - Guilford Glazer Faculty of Business and Management ( email )

P.O. Box 653
Beer-Sheva 84105
Israel
(972) 8 6472569 (Phone)
(972) 8 6477697 (Fax)

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