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)
Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Eugene F. Brigham, Phillip R. Daves
Chapter3: Risk And Return: Part Ii
Section: Chapter Questions
Problem 5MC: You have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand...
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![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)
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