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Market-wide illiquidity and the distribution of non-parametric stochastic discount factors

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  • Abad, David
  • Nieto, Belén
  • Pascual, Roberto
  • Rubio, Gonzalo

Abstract

Employing out-of-sample non-parametric estimation techniques, we show that market-wide liquidity risk matters for asset pricing independently of the specific functional form of the stochastic discount factor (SDF) and, therefore, of the asset pricing model specification. Market-wide illiquidity significantly affects the distribution of the SDF. Specifically, it boosts up the volatility of the SDF, causing minor effects on higher moments of its distribution. This finding is robust to the use of different sets of test assets in the estimation of the SDF, including equity and corporate bond portfolios, and the use of a high-dimensional data estimation procedure.

Suggested Citation

  • Abad, David & Nieto, Belén & Pascual, Roberto & Rubio, Gonzalo, 2023. "Market-wide illiquidity and the distribution of non-parametric stochastic discount factors," International Review of Financial Analysis, Elsevier, vol. 87(C).
    • Handle: RePEc:eee:finana:v:87:y:2023:i:c:s1057521923001667
    DOI: 10.1016/j.irfa.2023.102650
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    Cited by:

    1. Grau-Vera, David & Rubio, Gonzalo, 2024. "Risk-adjusted performance of new economy indices and thematic sectors," Research in International Business and Finance, Elsevier, vol. 71(C).

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    More about this item

    Keywords

    Market-wide illiquidity; Non-parametric stochastic discount factor; Volatility; skewness; and kurtosis of the model-free stochastic discount factor; market realized volatility; High dimensional data estimation;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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