No abstract

This paper shows that financial contagion risk is an important source of the risk premium. Intermediaries' contribution to aggregate financial contagion is estimated in a new state space framework and a tradable financial contagion portfolio is formed. More contagious intermediaries earn excess returns over less contagious ones that cannot be explained by commonly used factor models. The relative performance of contagious intermediaries is also priced in the cross section of stock returns. Stocks that co-move more strongly with contagious intermediaries earn monotonically greater returns. These results are robust to factor model specification, test assets, and time period considered.

Exchange traded funds (ETFs) provide a means for investors to access assets indirectly that may be accessible at a high cost otherwise. I show that liquidity segmentation can explain the tendency for ETFs to trade at a premium to net asset value (NAV) as well as the life‐cycle pattern in premiums. ETFs with larger NAV tracking error standard deviations (TESDs) tend to trade at higher premiums and the liquidity benefits offered by foreign ETFs and fixed income ETFs are revealed to be the most valuable to investors. Further tests validate that TESD has the desirable properties of a liquidity segmentation measure.