Illiquidity Contagion and Pricing of Commonality Risk: Evidence From a Dynamic Conditional Correlation Model
School of Business
This paper investigates the pricing of the commonality in liquidity risk in the U.S. stock market by using a more comprehensive measure of market illiquidity cost that can reflect the liquidity condition of broader asset markets, and by forming portfolios in a way that is consistent with the definition of the commonality risk. Estimating a conditional version of the Liquidity-Adjusted Capital Asset Pricing Model by the Dynamic Conditional Correlation approach, we find a commonality risk premium that is higher than those derived from alternative measures. The premium is time varying, with values being higher during periods of market turmoil.
Beyene, N., Huang, P., & Hueng, C. J. (2021). Illiquidity contagion and pricing of commonality risk: Evidence from a dynamic conditional correlation model. Finance Research Letters, 39: 101571. doi:10.1016/j.frl.2020.101571