Niklas Wagner (Passau University)

Give Me a Break: Is the Equity Premium a Trading Break Premium?

May 12, 2020 – 12.30

Abstract

This paper addresses the relation between market risk and expected market returns under periodic trading breaks. We propose a model where asset prices are driven by a diffusion process that operates during the trading day and a separate process that captures overnight price changes. Our empirical analysis shows that both components are important in explaining the equity market risk premium.
Trading breaks entail a lack of market functionality and liquidity and our results reveal that investors ask for a premium to hold the market portfolio overnight. Including additional state variables into the model, we find that uncertainty risk and illiquidity risk are both priced as well.