Pricing of liquidity risk: empirical evidence from Finland

This study investigates the pricing of liquidity risk in stock market using conditional Asset Pricing Models (APMs). The estimation is conducted in the Generalized Method of Moment (GMM) framework with a price of risk specification. The main interest is to find out whether liquidity is priced as a systematic source of risk or as an asset-specific characteristic. Tests are conducted on the Finnish stock market known for wide variations in liquidity. The sample period is from 1987 to 2004, and size portfolios are used as test assets. The results indicate that illiquidity is priced as a market-wide systematic risk and not as an asset-specific risk.