The Effects of Beta, Bid-Ask Spread, Residual Risk, and Size on Stock Returns

Merton's 26 recent extension of the CAPM proposed that asset returns are an increasing function of their beta risk, residual risk, and size and a decreasing function of the public availability of information about them. Associating the latter with asset liquidity and following Amihud and Mendelson's 2 proposition that asset returns increase with their illiquidity (measured by the bid-ask spread), we jointly estimate the effects of these four factors on stock returns.