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On the pricing of overnight market risk

Author

Listed:
  • Patrizia Perras

    (University of Passau)

  • Niklas Wagner

    (University of Passau)

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.

Suggested Citation

  • Patrizia Perras & Niklas Wagner, 2020. "On the pricing of overnight market risk," Empirical Economics, Springer, vol. 59(3), pages 1307-1327, September.
    • Handle: RePEc:spr:empeco:v:59:y:2020:i:3:d:10.1007_s00181-019-01714-4
    DOI: 10.1007/s00181-019-01714-4
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    References listed on IDEAS

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    More about this item

    Keywords

    Dynamic asset pricing; Trading breaks; Equity premium; Diffusion premium; Overnight jump premium;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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