Extreme Downside Liquidity Risk
Michael Ungeheuer & Stefan Ruenzi – University of Mannheim
Florian Weigert – University of St. Gallen

We investigate whether investors receive compensation for holding stocks with strong systematic liquidity risk in the form of extreme downside liquidity (EDL) risk. We show that the cross-section of expected stock returns reflects a premium for EDL risk. From 1969 to 2011, the average future return on stocks with strong EDL risk exceeds that of stocks with weak EDL risk by more than 4% annually, adjusted for the exposures to market return as well as size, value, and momentum. This premium is different from linear liquidity risk and cannot be explained by other firm characteristics and risk factors. Our results show that investors care about extreme joint realizations in liquidity and that asset pricing models that rely on linear sensitivities alone might be misspecified.


Michael Ungeheuer

Michael Ungeheuer studied business administration with majors in finance and econometrics at the University of Mannheim, Germany, graduating as a Diplom-Kaufmann in 2010. In the course of a Fulbright Scholarhip in 2008/2009 and during the spring of 2011, he completed an M.Sc. in Finance with concentrations in financial economics and econometrics, as well as financial engineering at the Illinois Institute of Technology in Chicago, USA.
He is now a PhD-candidate at the University of Mannheim’s Graduate School of Economics and Social Sciences. Michael works as a research assistant at the Chair of International Finance (Prof. Ruenzi). His research interests are in empirical asset pricing, specifically liquidity (risk) and the effect of non-linear dependence on the cross-section of stock returns. To know more…

 

“There is strong empirical evidence that individuals are particularly averse to large financial losses and require a premium for the occurence of rare disaster events. Linear correlations – commonly used to measure systematic risk in asset pricing – fail to measure increased dependence during these extreme events. I believe that our research ontail events and non-linear dependence helps better understand the impact of extreme events on the allocation of resources via financial markets.”

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