Annals of Finance

, Volume 14, Issue 2, pp 253–288 | Cite as

Asset market equilibrium with liquidity risk

  • Robert Jarrow
Research Article


This paper derives an equilibrium asset pricing model with endogenous liquidity risk. Liquidity risk is modeled as a stochastic quantity impact on the price from trading, where the size of the impact depends on trade size. Under a strong set of assumptions, we prove that a unique equilibrium liquidity cost process and a unique equilibrium price process exists for our economy. We characterize the market’s state price density, which enables the derivation of the risk-return relation for the stock’s expected return including liquidity risk. We derive a generalized intertemporal CAPM and consumption CAPM for these markets. In contrast to the traditional models without liquidity risk, there is an additional systematic liquidity risk factor which is related to the stock return’s covariation with the market’s stochastic liquidity cost. Traditional transaction costs are a special case of our formulation.


Liquidity risk Asset market equilibrium Systematic risk Intertemporal CAPM Consumption CAPM 

JEL Classification

G11 G12 D53 


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Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2017

Authors and Affiliations

  1. 1.Samuel Curtis Johnson Graduate School of ManagementCornell UniversityIthacaUSA
  2. 2.Kamakura CorporationHonoluluUSA

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