Downside liquidity risk premium: From the perspective of higher moment

Abstract

Considering the serious negative impact of crisis events on stock liquidity, we construct the liquidity skewness to depict the asymmetric distribution of liquidity, which is drawn inspiration from the idea of higher moment in statistics, to measure the downside liquidity risk. Our study focuses on the issue of downside liquidity risk premium in Chinese stock market, and further analyze its underlying source from the dual perspectives of behavior and risk. Our findings provide convincing evidence that the downside liquidity risk measured by liquidity skewness has a significant return premium, and the premium is long-term since the liquidity skewness has a persistent impact on the cumulative returns. Furthermore, the downside liquidity risk premium derives from risk compensation instead of behavioral factors such as mispricing and investor sentiment. The conclusions have certain theoretical value for improving and enriching the research on liquidity premium, clarifying the mechanism of the impact of downside change in liquidity on cross-sectional returns, and provide valuable references for investors to allocate portfolios that meet their own risk preferences and regulators to supervise the market.