Asset Pricing with Volatility-Free and Volatility-Only Liquidity Measures

with Bartosz Gebka and Georgios Xyngis, 2022, working paper. [pdf coming soon]

We construct volatility-free and volatility-only versions of popular liquidity measures and explore their asset pricing implications. In particular, we separate the frequency-specific dynamics of aggregate liquidity from market volatility by proposing a new spectral decorrelation method that explicitly accounts for the low-frequency dependence between these measures. Using conditional portfolio sorts, we demonstrate that the illiquidity premium observed in equities sorted across the short-term reversal dimension is simply a reflection of aggregate volatility risk.