Measuring Tail Risks at High Frequency

Brian Matthew Weller

Research output: Working paper

Abstract

I develop a new methodology for measuring tail risks using the cross section of bid-ask spreads. Market makers embed tail risk information into spreads because (1) they lose to arbitrageurs when changes to asset values exceed the cost of liquidity and (2) underlying price movements and potential costs are linear in factor loadings. Using this insight, simple cross-sectional regressions relating spreads and trading volume to factor betas can recover tail risks in real time for common factors in stock returns. The methodology disentangles financial and aggregate market risks during the 2007–2008 Financial Crisis; anticipates jump risks associated with Federal Open Market Committee announcements; and quantifies a sharp, temporary increase in market tail risk before and throughout the 2010 Flash Crash. The recovered time series of implied market risks also aligns closely with both realized market jumps and the VIX.
Original languageEnglish (US)
PublisherSocial Science Research Network (SSRN)
Number of pages60
Publication statusPublished - Apr 26 2016

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Weller, B. M. (2016). Measuring Tail Risks at High Frequency. Social Science Research Network (SSRN).