of return: r r r One-period liquidation cost: 0 cL cI   Investor Type Net Rate of Return   1 r r cL r cI 2 r r cL/2 r cI/2 . . . . . . . . . . . . n r r cL/n r cI/n     These net rates of return would be inconsistent with a market in equilibrium, because with equal gross rates of return all investors would prefer to invest in zero-transaction-cost T-bills. As a result, both class L and class I stock prices must fall, causing their expected re- turns to rise until investors are willing to hold these shares. Suppose, therefore, that each gross return is higher by some fraction of liquidation cost. Specifically, assume that the gross expected return on class L stocks is r xcL and that of class I stocks is r ycI. The net rate of return on class L stocks to an investor with a hori- zon of h will be (r xcL) cL/h r cL(x 1/h). In general, the rates of return to in- vestors will be:       18 This simple structure of liquidation costs allows us to derive a correspondingly simple solution for the effect of liquidity on ex- pected returns. Amihud and Mendelson used a more general formulation, but then needed to rely on complex and more difficult- to-interpret mathematical programming. All that matters for the qualitative results below, however, is that illiquidity costs be less onerous to longer-term investors. III. Equilibrium In Capital Markets 9. The Capital Asset Pricing Model The McGraw−Hill Companies, 2001           282 PART III Equilibrium in Capital Markets