The Epstein–Zin Model with Liquidity Extension

Weimin Liu; Di Luo; Huainan Zhao

doi:10.1111/fire.12098

The Epstein–Zin Model with Liquidity Extension

Weimin Liu
, Di Luo (Lead / Corresponding author)
, Huainan Zhao

Research output: Contribution to journal › Article › peer-review

3 Citations (Scopus)

27 Downloads (Pure)

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 language	English
Pages (from-to)	113-146
Number of pages	34
Journal	Financial Review
Volume	51
Issue number	1
DOIs	https://doi.org/10.1111/fire.12098
Publication status	Published - 12 Jan 2016

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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. ",

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AB - 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.

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The Epstein–Zin Model with Liquidity Extension

Abstract

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