Liquidity Premium in the Presence of Stock Market Crises and Background Risk

Quantitative Finance, Vol 15(1), 79-90, 2015

27 Pages Posted: 18 Jan 2011 Last revised: 2 Apr 2017

See all articles by Sergey Isaenko

Sergey Isaenko

Concordia University, Quebec - Department of Finance

Rui Zhong

The University of Western Australia - UWA Business School

Date Written: January 5, 2013

Abstract

We analyze a portfolio optimization problem for a long-term investor in the presence of stock market crises. A crisis includes a crash of the stock market price, a sharp increase of its volatility and dramatic deterioration of liquidity. We model the stock market illiquidity by means of convex transaction costs that mimic the presence of an effective bid-ask spread that increases with the size of a trade. We find that the existence of stock market crises results in a significant liquidity premium. Furthermore, the presence of background risk has a negative impact on the liquidity premium.

Keywords: Portfolio Choice, Liquidity

JEL Classification: G11

Suggested Citation

Isaenko, Sergey and Zhong, Rui, Liquidity Premium in the Presence of Stock Market Crises and Background Risk (January 5, 2013). Quantitative Finance, Vol 15(1), 79-90, 2015, Available at SSRN: https://ssrn.com/abstract=1742448 or http://dx.doi.org/10.2139/ssrn.1742448

Sergey Isaenko (Contact Author)

Concordia University, Quebec - Department of Finance ( email )

John Molson School of Business
Concordia University. 1455 de Maisonneuve Blvd.W.
Montreal, Quebec, H3G 1M8
Canada
1-514-848-2424 ext.2797 (Phone)
1-514-848-4500 (Fax)

Rui Zhong

The University of Western Australia - UWA Business School ( email )

35 Stirling Highway
Crawley, Western Australia 6009
Australia

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