Slumping Shoulders and Fat Tail: Market Microstructure and Kurtosis of Stock Return

39 Pages Posted: 8 Oct 2013 Last revised: 24 Nov 2018

See all articles by Suman Banerjee

Suman Banerjee

Stevens Institute of Technology; Stevens Institute of Technology

Lili Dai

University of New South Wales (UNSW)

David A. Lesmond

Tulane University - A.B. Freeman School of Business

Thomas H. Noe

University of Oxford - Said Business School; University of Oxford - Balliol College; Bank of Finland; European Corporate Governance Institute

Date Written: March 21, 2014

Abstract

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

Banerjee, Suman and Dai, Lili and Lesmond, David A. and Noe, Thomas H., Slumping Shoulders and Fat Tail: Market Microstructure and Kurtosis of Stock Return (March 21, 2014). Available at SSRN: https://ssrn.com/abstract=2337045 or http://dx.doi.org/10.2139/ssrn.2337045

Suman Banerjee (Contact Author)

Stevens Institute of Technology ( email )

525 River Street
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2012613689 (Phone)

Stevens Institute of Technology ( email )

Hoboken, NJ 07030
United States

Lili Dai

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

HOME PAGE: http://sites.google.com/site/ldaiprofile

David A. Lesmond

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
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New Orleans, LA 70118
United States
504-865-5665 (Phone)
504-865-6751 (Fax)

Thomas H. Noe

University of Oxford - Said Business School ( email )

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Oxford, OX1 3BJ
United Kingdom

University of Oxford - Balliol College ( email )

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Oxford, OX1 3BJ
United Kingdom

Bank of Finland ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

European Corporate Governance Institute ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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