Pricing liquidity risk with heterogeneous investment horizons

We develop a liquidity-based asset pricing model featuring investors with heterogeneous investment horizons and stochastic transaction costs. In an equilibrium where all investors invest in all assets (integration), we nd that the existence of investors with heterogeneous horizons, as opposed to homogeneous horizons, reduces the importance of liquidity risk relative to the standard CAPM market risk and generates a more complex eect of expected liquidity. In an equilibrium where short-term investors do not invest in some more illiquid assets (partial segmentation), our model generates an additional segmentation premium for these assets. We estimate the model for the cross-section of U.S. stocks using GMM and nd that our heterogeneous-horizon asset pricing model fares better than a standard liquidity-adjusted CAPM. The segmented version of our model delivers the best cross-sectional t and generates a substantial eect of expected liquidity on ex