Analyzing the Effect of Liquidity on Asset Pricing: using Epstein-Zin Model in the Iranian Capital Market

Liquidity is one of the most important aspects of development in financial markets and oneof the risk factors of financial assets. In this study, liquidity risk is also used as a factor tomodify the Epstein-Zin model, and its performance is evaluated against traditionalconsumption-based asset pricing models. In order to adjust the Epstein-Zin model in thisstudy, the liquidity factors of Liu (2006), Turnover ratio, Gopalan and cGibbs have beenapplied and the used data are for 48 stock companies from 2009 to 2017. The resultsindicate that the adjusted model has a higher adjusted-
 than the traditional consumptionbasedcapital asset pricing model and the traditional Epstein-Zin model, and indicates thatliquidity is a significant risk factor and adds a significant explanatory power to model.Thus, overall, the results of this study show that liquidity risk is a pricing factor and itsincorporation into pricing models leads to improved model performance.