Market imperfections and the implications for asset pricing

Saffi, Pedro (2007) Market imperfections and the implications for asset pricing. Doctoral thesis, University of London: London Business School.

Abstract

This dissertation investigates how different types of market frictions affect security prices and trading behavior. The first chapter studies how liquidity risk and non-tradable wealth affect asset pricing. First I derive a model with random endowment shocks and liquidity risk, showing that assets with higher liquidity or returns when non-tradable wealth is low command lower expected returns. Then, I test it on US stocks from January 1962 to December 2004. The extra terms due to entrepreneurial income (the non-tradeable income proxy) reduce liquidity risk premia by almost 40%, with an impact of -0.45% per year on expected returns of illiquidity-sorted portfolios. Liquidity risk as a whole has a yearly premium equal to 1.06%. The second chapter focuses on the impact of dispersion of opinions and asymmetric information on stock. turnover near public inormation. releases. I develop a model and test how stock. turnover around earnings announcements in the US is related to proxies of dispersion of opinions and information asymmetry, finding that an increase in dispersion accelerates trading, while a similar increase in delays it. The final chapter is a study about the impact of short-sales constraints on stock price efficiency. We use a dataset with over 85.7 million. lending supply postings and 46.4 million lending transactions from January 2004 to June 2006. This information is available weekly for 17,015 stocks in 26 markets around the world. The main findings are as follows. First, short-sale constraints are associated with lower price efficiency. Stocks with limited lending supply and high borrowing fees respond more slowly to market wide shocks. Second, short-sale constraints have a small impact on the distribution of weekly stock returns. Limited lending supply is associated with higher skewness, but not with fewer extreme negative returns. Third, stocks with limited lending supply and higher borrowing fees are associated with lower R2s on average.