Slumping Shoulders and Fat Tail: Market Microstructure and Kurtosis of Stock Return
39 Pages Posted: 8 Oct 2013 Last revised: 24 Nov 2018
Date Written: March 21, 2014
This paper investigates the hypothesis that market microstructure is an important determinant of stock-return kurtosis. We first develop a simple model where an informed investor has private information about the firm's fundamentals and marketmaker has private information about the non-fundamentals, particularly concerning the structure of noise-traders' demand. The model shows that these market frictions can generate significant kurtosis in asset return distribution. Consistently, findings in our empirical analyses support this conjecture. We find a positive and causal association between liquidity cost in stock market and kurtosis in stock return. This association is robust to various specifications, and different proxies for liquidity cost and return kurtosis. It is even present when we control for the endogeneity and reverse causality concerns. Our findings have implications for research in asset pricing and corporate finance, and also add to the knowledge of practitioners, especially from risk management perspective.
Keywords: Microstructure, Liquidity Cost, Return Kurtosis
JEL Classification: G12, G14
Suggested Citation: Suggested Citation