Extreme Downside Liquidity Risk
78 Pages Posted: 1 Apr 2013 Last revised: 12 Mar 2018
Date Written: March 8, 2018
We merge the literature on downside return risk with that on systematic liquidity risk and introduce the concept of extreme downside liquidity (EDL) risk. We show that the cross-section of expected stock returns reflects a premium for EDL risk. Strong EDL risk stocks deliver a positive risk premium of more than 4% p.a. as compared to weak EDL risk stocks. The effect is more pronounced after the market crash of 1987. It is not driven by linear liquidity risk or by extreme downside return risk, and it cannot be explained by other firm characteristics or other systematic risk factors.
Keywords: Asset Pricing, Crash Aversion, Downside Risk, Liquidity Risk, Tail Risk
JEL Classification: C12, C13, G01, G11, G12, G17
Suggested Citation: Suggested Citation