Liquidity and asset pricing under the three-moment CAPM paradigm

We examine whether the use of the three-moment capital asset pricing model can account for liquidity risk. We also make a comparative analysis of a four-factor model based on Fama2013French and Pástor2013Stambaugh factors versus a model based solely on stock characteristics. Our findings suggest that neither of the models captures the liquidity premium nor do stock characteristics serve as proxies for liquidity. We also find that sensitivities of stock return to fluctuations in market liquidity do not subsume the effect of characteristic liquidity. Furthermore, our empirical findings are robust to differences in market microstructure or trading protocols between NYSE/AMEX and NASDAQ.