Funding Risk, Market Liquidity, Market Volatility and the Cross-Section of Asset Returns

55 Pages Posted: 30 Jan 2015 Last revised: 29 Oct 2016

Jean-Sebastien Fontaine

Bank of Canada

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques; University of Montreal

Sermin Gungor

Bank of Canada

Date Written: October 1, 2016

Abstract

We find strong evidence of a funding risk premium in the cross-section of asset returns. Our estimate for the price of funding risk is robust across Treasury bonds, corporate bonds, equities, and hedge funds. Funding shocks pose a risk to investors because they exacerbate the illiquidity and volatility of securities, increase the dispersions of asset illiquidity and volatility, and decrease contemporaneous returns. Our price-of-risk estimates are also robust to using mimicking portfolio returns, alternative portfolio sorts, traditional test assets, monthly returns or quarterly returns. Funding shocks are not subsumed by common proxies for market-wide illiquidity or dealers' balance sheet risk.

Keywords: Funding risk, Stock returns, Limits to arbitrage, Market liquidity, Volatility

JEL Classification: E43, H12

Suggested Citation

Fontaine, Jean-Sebastien and Garcia, René and Gungor, Sermin, Funding Risk, Market Liquidity, Market Volatility and the Cross-Section of Asset Returns (October 1, 2016). Available at SSRN: https://ssrn.com/abstract=2557211

Jean-Sebastien Fontaine (Contact Author)

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

HOME PAGE: http://www.jean-sebastienfontaine.com

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques ( email )

C.P. 6128, succursale Centre-Ville
3150, rue Jean-Brillant, bureau C-6027
Montreal, Quebec H3C 3J7
Canada
514-985-4014 (Phone)

University of Montreal ( email )

United States

Sermin Gungor

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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