You recently found out that when the market is in recession, ALL assets seem to suffer from some degree of liquidity problems as there are less trades than usual, and thus it is hard to sell an asset without losing some of its fair value. So, you concluded that at least some portion of liquidity risk must be systematic in nature and therefore it must be compensated by the market. To verify this, you cut the market portfolio in half by the illiquidity measure developed by Amihud (2002) (So that you have one relatively liquid portfolio and one relatively illiquid portfolio. Assume that this measure is reliable.] and calculated the market liquidity risk premium as follows: Market liquidity risk premium = Expected return on the illiquid portfolio - Expected returm on the liquid portfolio = [E(R)- E(R1)) Then you formed 5 portfolios from the entire market based on liquidity (Amihud measure) and estimute the factor loading 8 (called liquidity betu) of cach portfolio using [Rn - Ri] as the factor in a factor model and got the following results: Portfolio on Liquidity Liquidity Beta (factor loading) Low 2 3 4 Iligh 1.1 2.4% 0.7 1.3 7.5% 0.9 6.7% 1.5 4.1% Return 8.3% (a) Assuming that all your estimations are correct, determine whether your measure of liquidity risk cun he a systematic risk factor from the ahove table. (Prove a brief explanation)
You recently found out that when the market is in recession, ALL assets seem to suffer from some degree of liquidity problems as there are less trades than usual, and thus it is hard to sell an asset without losing some of its fair value. So, you concluded that at least some portion of liquidity risk must be systematic in nature and therefore it must be compensated by the market. To verify this, you cut the market portfolio in half by the illiquidity measure developed by Amihud (2002) (So that you have one relatively liquid portfolio and one relatively illiquid portfolio. Assume that this measure is reliable.] and calculated the market liquidity risk premium as follows: Market liquidity risk premium = Expected return on the illiquid portfolio - Expected returm on the liquid portfolio = [E(R)- E(R1)) Then you formed 5 portfolios from the entire market based on liquidity (Amihud measure) and estimute the factor loading 8 (called liquidity betu) of cach portfolio using [Rn - Ri] as the factor in a factor model and got the following results: Portfolio on Liquidity Liquidity Beta (factor loading) Low 2 3 4 Iligh 1.1 2.4% 0.7 1.3 7.5% 0.9 6.7% 1.5 4.1% Return 8.3% (a) Assuming that all your estimations are correct, determine whether your measure of liquidity risk cun he a systematic risk factor from the ahove table. (Prove a brief explanation)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
![You recently found out that when the market is in recession, ALL assets seem to suffer from some
degree of liquidity problems as there are less trades than usual, and thus it is hard to sell an asset
without losing some of its fair value. So, you concluded that at least some portion of liquidity risk
must be systematic in nature and therefore it must be compensated by the market. To verify this,
you cut the market portfolio in half by the illiquidity measure developed by Amihud (2002) (So
that you have one relatively liquid portfolio and one relatively illiquid portfolio. Assume that this
measure is reliable.] and calculated the market liquidity risk premium as follows:
Market liquidity risk premium = Expected return on the illiquid portfolio -
Expected returm on the liquid portfolio = [E(R)- E(R1))
Then you formed 5 portfolios from the entire market based on liquidity (Amihud measure) and
estimute the factor loading 8 (called liquidity betu) of cach portfolio using [Rn - Ri] as the factor
in a factor model and got the following results:
Portfolio on Liquidity
Liquidity Beta (factor loading)
Low
2
3
4
Iligh
1.1
2.4%
0.7
1.3
7.5%
0.9
6.7%
1.5
4.1%
Return
8.3%
(a) Assuming that all your estimations are correct, determine whether your measure of liquidity
risk cun he a systematic risk factor from the ahove table. (Prove a brief explanation)](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fa0c0456c-8734-406e-ac78-99e3a3a2f504%2F8cb01882-35f6-49d6-81fd-82746e391905%2Fjxwxbhw_processed.jpeg&w=3840&q=75)
Transcribed Image Text:You recently found out that when the market is in recession, ALL assets seem to suffer from some
degree of liquidity problems as there are less trades than usual, and thus it is hard to sell an asset
without losing some of its fair value. So, you concluded that at least some portion of liquidity risk
must be systematic in nature and therefore it must be compensated by the market. To verify this,
you cut the market portfolio in half by the illiquidity measure developed by Amihud (2002) (So
that you have one relatively liquid portfolio and one relatively illiquid portfolio. Assume that this
measure is reliable.] and calculated the market liquidity risk premium as follows:
Market liquidity risk premium = Expected return on the illiquid portfolio -
Expected returm on the liquid portfolio = [E(R)- E(R1))
Then you formed 5 portfolios from the entire market based on liquidity (Amihud measure) and
estimute the factor loading 8 (called liquidity betu) of cach portfolio using [Rn - Ri] as the factor
in a factor model and got the following results:
Portfolio on Liquidity
Liquidity Beta (factor loading)
Low
2
3
4
Iligh
1.1
2.4%
0.7
1.3
7.5%
0.9
6.7%
1.5
4.1%
Return
8.3%
(a) Assuming that all your estimations are correct, determine whether your measure of liquidity
risk cun he a systematic risk factor from the ahove table. (Prove a brief explanation)
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education