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Recent papers in asset pricing have added a market-wide liquidity factor to traditional portfolio-based or factor models. None of these papers has reported any evidence on how aggregate liquidity behaves together with consumption growth risk as measured by ultimate consumption risk. This paper covers this gap by providing a comprehensive explanation of the cross-sectional variation of average returns under market-wide illiquidity shocks. It derives closed-form expressions for consumption-based stochastic discount factors adjusted by aggregate liquidity shocks and tests alternative models specifications.
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