Journal of Financial Markets 3 (2000) 69}81 The capital asset pricing model and the liquidity e!ect: A theoretical approach  Gady Jacoby*, David J. Fowler, Aron A. Gottesman Department of Accounting and Finance, Faculty of Management, University of Manitoba, Winnipeg, MB, Canada R3T 5V4 Schulich School of Business, York University, Canada Abstract In this paper we develop a CAPM-based model to demonstrate that the true measure of systematic risk } when considering liquidity costs } is based on net (after bid}ask spread) returns. We further examine the relationship between the expected return and the future spread cost within the CAPM framework. This positive relationship in our model is found to be convex. This "nding di!ers from Amihud and Mendelson's (1986) concave relationship, but it agrees with empirical evidence obtained by Brennan and Subrah- manyam (1996).  2000 Elsevier Science B.V. All rights reserved. JEL classixcation: G12 Keywords: Capital asset pricing model; Bid}ask spread; Liquidity; Market frictions; Beta  The authors would like to thank Yaacov Amihud, Narat Charupat, Sandra Betton, seminar participants at the 1997 Financial Management Association meeting, and the York University Finance Department Colloquium for their helpful remarks. Thanks are also due to the editor, Avanidhar Subrahmanyam, and an anonymous referee for their thoughtful suggestions. All errors are the exclusive fault of the authors. In addition, Jacoby would like to thank the Ontario Graduate Scholarship Fund and the Financial Services Program at York University, for their "nancial support. Gottesman thanks Social Sciences and Humanities Research Council of Canada for "nancial support. * Corresponding author. Tel.: #1-204-474-9331; fax:#1-204-474-7545. E-mail address: jacobyg@ms.umanitoba.ca (G. Jacoby) 1386-4181/00/$ - see front matter  2000 Elsevier Science B.V. All rights reserved. PII: S 1 3 8 6 - 4 1 8 1 ( 9 9 ) 0 0 0 1 3 - 0