A Market-Based Funding Liquidity Measure

Abstract

We construct a traded funding liquidity measure from stock returns. Guided by a model, we extract the measure as the return spread between two beta-neutral portfolios constructed using stocks with high and low margin, to control for stocks' sensitivities to the aggregate funding shocks. Our measure is correlated with other funding liquidity proxies. It delivers a positive risk premium that cannot be explained by existing risk factors. A model augmented by the proposed funding liquidity factor has superior pricing performance for various portfolios. Despite evident co-movement, this factor contains additional information that is not subsumed by market liquidity movement.

Keywords: Funding Liquidity, Margin Requirements, Traded Risk Factor

JEL Classification: G10, G11, G23