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Keywords:

  • Asset-pricing model;
  • illiquidity effect;
  • predicted factor risk premium;
  • model betas

Abstract

This paper presents a simplified single period asset-pricing model adjusted for liquidity and tests it for the Nordic markets. The detailed empirical evidence is presented from Finnish test case. Empirical testing of small yet developed markets is motivated by the increased relevance of the illiquidity effect for illiquid assets/markets. The main evidence reports liquidity risk makes sufficiently larger part of predicted factor risk premium than the market risk, contrary to comparable US evidence. This highlights the ability of liquidity related model betas in capturing the time variation in expected returns across illiquid (Nordic) markets than market beta.