Funding Liquidity, Market Liquidity and the Cross-Section of Stock Returns
Following
theory, we check that funding risk connects illiquidity, volatility and returns
in the cross-section of stocks. We show that the illiquidity and volatility of stocks
increase with funding shocks, while contemporaneous returns decrease with funding
shocks. The dispersions of illiquidity, volatility and returns widen following funding
shocks. Funding risk is priced, generating a returns spread of 4.25 percent (annually)
between the most and least illiquid portfolios, and of 5.30 percent between the
most and least volatile portfolios. Estimates are robust using mimicking
portfolio returns, alternative portfolio sorts, traditional test assets, other
risk factors, monthly returns or quarterly returns.
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