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Illiquidity contagion and pricing of commonality risk: Evidence from a dynamic conditional correlation model

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  • Beyene, Nardos
  • Huang, Peng
  • Hueng, C. James

Abstract

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.

Suggested Citation

  • Beyene, Nardos & Huang, Peng & Hueng, C. James, 2021. "Illiquidity contagion and pricing of commonality risk: Evidence from a dynamic conditional correlation model," Finance Research Letters, Elsevier, vol. 39(C).
    • Handle: RePEc:eee:finlet:v:39:y:2021:i:c:s1544612320302993
    DOI: 10.1016/j.frl.2020.101571
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    References listed on IDEAS

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    More about this item

    Keywords

    Commonality risk premium; Illiquidity contagion; Liquidity-adjusted capital asset pricing model;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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