The Price of Tail Risk in Liquidity and Returns

The likelihood of systemic risk presents a challenge for modern finance. In particular, it is important to know to what extent the market exacts a premium for exposure to ’tail risk’. In this paper, we use a simple estimate of two types of tail risk, in returns and liquidity, and measure their performance in a Fama and French (1993) style factor model. Empirically, return tail risk induces a monotonic pattern: stocks that are more sensitive to...