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On the pricing of overnight market risk

Patrizia Perras and Niklas Wagner ()
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Patrizia Perras: University of Passau
Niklas Wagner: University of Passau

Empirical Economics, 2020, vol. 59, issue 3, No 11, 1307-1327

Abstract: Abstract This paper addresses the relation between market risk and expected market returns under periodic trading breaks. We propose a model where asset prices are driven by a diffusive process that operates during the trading day and a separate process that captures overnight price changes. Our empirical analysis shows that both components are important in explaining the equity market risk premium. Trading breaks entail a lack of market functionality and liquidity, and our results reveal that investors ask for a premium to hold the market portfolio overnight. Considering additional state variables in the model, we find that uncertainty risk and illiquidity risk are both significantly priced as well.

Keywords: Dynamic asset pricing; Trading breaks; Equity premium; Diffusion premium; Overnight jump premium (search for similar items in EconPapers)
JEL-codes: G12 C51 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1007/s00181-019-01714-4

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