Joint Extreme Events in Equity Returns and Liquidity and their Cross-Sectional Pricing Implications

Abstract

We merge the literature on downside return risk and liquidity risk and introduce the concept of extreme downside liquidity (EDL) risks. The cross-section of stock returns reflects a premium if a stock's return (liquidity) is lowest at the same time when the market liquidity (return) is lowest. This effect is not driven by linear or downside liquidity risk or extreme downside return risk and is mainly driven by more recent years. There is no premium for stocks whose liquidity is lowest when market liquidity is lowest.

Keywords: Asset Pricing, Crash Aversion, Downside Risk, Liquidity Risk, Tail Risk

JEL Classification: C12, C13, G01, G11, G12, G17