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The Epstein-Zin model with liquidity extension

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posted on 10.02.2017 by Weimin Liu, Di Luo, Huainan Zhao
In this paper, we extend the Epstein and Zin (1989, 1991) 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 (1997) distance than the traditional consumption-based capital asset pricing model (CCAPM) 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.

History

School

  • Business and Economics

Department

  • Business

Published in

Financial Review

Volume

51

Issue

1

Pages

113 - 146

Citation

LIU, W., LUO, D. and ZHAO, H., 2016. The Epstein-Zin model with liquidity extension. Financial Review, 51(1), pp. 113-146.

Publisher

© The Eastern Finance Association. Published by Wiley

Version

AM (Accepted Manuscript)

Publisher statement

This work is made available according to the conditions of the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International (CC BY-NC-ND 4.0) licence. Full details of this licence are available at: https://creativecommons.org/licenses/by-nc-nd/4.0/

Publication date

2016-01-12

Notes

This is the peer reviewed version of the following article: LIU, W., LUO, D. and ZHAO, H., 2016. The Epstein-Zin model with liquidity extension. Financial Review, 51(1), pp. 113-146, which has been published in final form at http://dx.doi.org/10.1111/fire.12098. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving.

ISSN

0732-8516

Language

en

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