Pricing Liquidity Risk with Heterogeneous Investment Horizons

We develop a new asset pricing model with stochastic transaction costs and investors with heterogenous horizons. Short-term investors hold only liquid assets in equilibrium. This generates
segmentation effects in the pricing of liquid versus illiquid assets. Specifically, the liquidity (risk) premia of illiquid assets are determined by the heterogeneity in investor horizons and by the correlation between liquid and illiquid assets. We estimate our model for the cross-section of U.S. stocks and find that it fits average returns substantially better than a standard liquidity CAPM. Allowing for heterogenous horizons also leads to much larger estimates for the liquidity premia.