The liquidity premium and long-run risk

Purpose This paper examines whether changes in the liquidity premium before and after 2000 can be explained by shifts in exposures to long-run risk. Design/methodology/approach We estimate the risk exposures of liquidity-based portfolios to long-run consumption and investment risk factors, following the framework of Hansen et al. (2008). Findings We find that illiquid stocks exhibit significantly larger exposures to both risk factors than liquid stocks, both over the full sample period from 1964 to 2023 and in the pre-2000 subsample, consistent with the positive liquidity premium observed during these intervals. Originality/value After 2000, the negative exposure of illiquid stocks to the long-run consumption risk factor accounts for the diminishing liquidity premium observed in this period.