Time-Varying Crash Risk: The Role of Stock Market Liquidity

Peter Christoffersen, Bruno Feunou, Yoontae Jeon and Chayawat Ornthanalai

Staff Working Papers from Bank of Canada

Abstract: We estimate a continuous-time model with stochastic volatility and dynamic crash probability for the S&P 500 index and find that market illiquidity dominates other factors in explaining the stock market crash risk. While the crash probability is time-varying, its dynamic depends only weakly on return variance once we include market illiquidity as an economic variable in the model. This finding suggests that the relationship between variance and jump risk found in the literature is largely due to their common exposure to market liquidity risk. Our study highlights the importance of equity market frictions in index return dynamics and explains why prior studies find that crash risk increases with market uncertainty level.

Keywords: Asset Pricing; Econometric and statistical methods; Financial stability (search for similar items in EconPapers)
JEL-codes: G01 G12 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2016
New Economics Papers: this item is included in nep-cse, nep-fmk and nep-rmg
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:16-35

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