Funding Liquidity Risk and the Cross-Section of Stock Returns
Bank of Canada
Date: February 7, 2014
Time: 10:00 am - 11:30 am
Location: Room 002
Intermediaries should transmit funding shocks to the cross-section of returns. Stocks that experience low returns when funding becomes scarce should exhibit higher illiquidity, higher volatility and ultimately higher risk premium. This paper documents this mechanism empirically. We show that the illiquidity and volatility of individual portfolios are positively associated with the value of funding liquidity, a measure of funding scarcity, while the portfolio returns are negatively correlated. In addition, the cross-section dispersion of illiquidity, volatility, and returns widens when funding conditions deteriorate. We find that this risk is priced. The funding liquidity risk premium explains the cross-section of returns across liquidity-, volatility-, and size-sorted portfolios. Overall, our results provide strong support for the prediction that funding liquidity plays a significant role in the determination of equity liquidity, volatility, and risk premium.
For more information, please contact Karen Robertson at: karen.robertson [at] mcgill.ca.