The Epstein-Zin Model with Liquidity Extension

Weimin Liu, Di Luo, Huainan Zhao

Research output: Journal PublicationArticlepeer-review

2 Citations (Scopus)

Abstract

In this paper, we extend the Epstein-Zin model with liquidity risk and assess the extended model's performance against the traditional consumption pricing models. We show that liquidity is a significant risk factor, and it adds considerable explanatory power to the model. The liquidity-extended model produces both a higher cross-sectional R2 and a smaller Hansen and Jagannathan distance than the traditional consumption-based capital-asset pricing model and the original Epstein-Zin model. Overall, we show that liquidity is both a priced factor and a key contributor to the extended Epstein-Zin model's goodness-of-fit.

Original languageEnglish
Pages (from-to)113-146
Number of pages34
JournalFinancial Review
Volume51
Issue number1
DOIs
Publication statusPublished - 1 Feb 2016

Keywords

  • Consumption-based asset pricing
  • Liquidity risk
  • Model performance

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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