The Pricing of Liquidity Risk and Accounting Quality in Canada

Abstract

I investigate the pricing of liquidity risk and accounting quality in Canadian equity markets. I report evidence that security prices in Canada are significantly affected by liquidity risk, and that this association is significant throughout the year, with a spike in January. However, despite positive correlation between the accounting quality and liquidity factors, the accounting quality factor is not significantly different from zero except in January, and firm-specific estimates of exposure to the accounting quality factor (i.e. factor betas) have no predictive power for future returns. I conclude that while investments in accounting quality could possibly mitigate liquidity risk, accounting quality is unlikely to have a direct effect on the cost of capital of Canadian firms.