Equity Risk Premium Estimation Models: A study of the effects of trading liquidity on traditional asset pricing models

I ask whether added liquidity factors improve the ability of the Sharp-Lintner CAPM and the Fama French three-factor model to explain asset returns, ex-post, in the Norwegian stock market. Through cross-sectional and time-series regression tests, on both the original and the liquidity-augmented versions of the equity risk premium models, I search for a reversed liquidity premium in the period 2006-2011. I find that the liquidity factors, represented by the bid-ask spread and turnover, marginally improve the empirical ability of the models to explain asset prices and conclude that there is empirical support for a multidimensional liquidity premium. The implications of my results contradict flight-to-liquidity theory and suggest that different dimensions of liquidity are rewarded a premium in different stages of the business-cycle - offering liquidity based rationale for the size and value-effect