The quality premium with leverage and liquidity constraints

Ana González-Urteaga and Gonzalo Rubio

International Review of Financial Analysis, 2021, vol. 75, issue C

Abstract: This research analyzes the causes of the quality premium, one of the most intriguing and successful investment strategies in equity markets. While previous research has argued that psychological biases explain the performance of the quality minus junk factor, our paper analyzes a leverage constraint explanation within a rational risk-based framework. The quality factor is multidimensional in nature, which suggests that a combination of risk, frictions, and behavioral biases is a reasonable explanation. Once we incorporate margin requirements and liquidity restrictions, we find that tighter conditions result in a higher intercept and a lower slope for the empirically implemented capital asset pricing model when using 10 quality-sorted portfolios. Our paper shows that, indeed, not only behavioral biases explain quality, but also market frictions account for its performance.

Keywords: Margin requirements; Quality premium; Funding constraints; Liquidity constraints; Security market line (search for similar items in EconPapers)
JEL-codes: C12 G14 N22 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:75:y:2021:i:c:s1057521921000429

DOI: 10.1016/j.irfa.2021.101699

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