1. Examining the dynamics of illiquidity risks within the phases of the business cycle
- Author
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Olivier Mesly, William F. Rentz, Alfred L Kahl, François-Éric Racicot, University of Ottawa [Ottawa], and ICN Business School
- Subjects
050208 finance ,Risk premium ,05 social sciences ,Instrumental variable ,Illiquidity ,Context (language use) ,Risk factor (finance) ,Kalman filter ,[SHS.ECO]Humanities and Social Sciences/Economics and Finance ,[SHS]Humanities and Social Sciences ,Fama-French five-factor model ,Robust IV algorithm ,Dynamics (music) ,lcsh:Finance ,lcsh:HG1-9999 ,0502 economics and business ,Business cycle ,Econometrics ,Economics ,General Earth and Planetary Sciences ,JEL: C - Mathematical and Quantitative Methods/C.C5 - Econometric Modeling/C.C5.C58 - Financial Econometrics ,050207 economics ,JEL: G - Financial Economics/G.G1 - General Financial Markets/G.G1.G12 - Asset Pricing • Trading Volume • Bond Interest Rates ,General Environmental Science - Abstract
The Fama-French (FF) five-factor model is cast into a dynamic setting to capture the impact of illiquidity over the phases of the business cycle on the returns of the passive FF twelve sector portfolios. We use two dynamic approaches, Kalman filtering and a recursive/rolling robust instrumental variables (IV) algorithm cast into a GMM framework, to determine time-varying alpha and beta estimates. Our principal result is that the Kalman filter approach supports the hypothesis that illiquidity is an important risk factor in a dynamic context. However, the only factor found to matter in the dynamic GMM approach is the market risk premium. Nevertheless, illiquidity may be prescient with respect to financial crises. Keywords: Illiquidity, Fama-French five-factor model, Kalman filter, Robust IV algorithm, JEL Classification: C58, G12
- Published
- 2019
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