Quality portfolios and funding liquidity crises

Abstract

ABSTRACT This paper shows that the quality minus junk (QMJ) factor and quality-sorted portfolios contain information about funding liquidity crisis. There is a strong and positive relation between the behavior of the QMJ factor and the intensity of funding liquidity crises. This is the case even if we control for the profitability factor, the St. Louis Fed Financial Stress Index, and the market portfolio return. However, we do not find a similar significant relation with respect to market-wide illiquidity. Moreover, the quality-based volatility bound is a strong predictor of the probability of future funding liquidity recessions.