(An) empirical study on extreme liquidity risk in the Korean stock market

Abstract

This paper empirically analyzes the effect of economy-wide extreme liquidity risk in the Korean stock market from 1990 to 2020. Daily illiquidity estimates of cross-section of stocks are pooled each month, and threshold exceedances on the right tail are used to measure extreme liquidity risk. The equal-weighted zero-cost decile portfolio sorted by extreme liquidity risk beta generates an average return of 1.24% along with positive and economically large abnormal returns even after considering traditional factors and aggregate liquidity factor. The extreme liquidity risk is also distinct from Pástor and Stambaugh (2003) traded liquidity factor or Kelly and Jiang (2014) tail return risk factor in the Korean market. Portfolio analyses exhibit that extreme liquidity risk with the 90th percentile threshold partially reflects a premium on the cross-section of expected stock returns, and the impact on the future stock returns is highlighted during the post-Asian financial crisis period.