A Theory of the Dynamics of Security Returns around Market Closures



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    • University of Michigan. The author would like to thank the following individuals for their helpful comments: Alex Kane, Gautam Kaul, Naveen Khanna, John M. Marshall, Greg Niehaus, M. P. Narayanan, Michael Rothschild, Maxwell Stinchcombe, René Stulz (the editor), and an anonymous referee. I would also like to thank David Heike for research assistance. Obviously, any errors are the responsibility of the author.


Numerous empirical studies document patterns in the means and variances of security returns measured over periods that are punctuated by market closures. This article develops a multiperiod model in which closures delay the resolution of uncertainty, thereby redistributing risk across time and agents. Since agents are risk averse in the model, this redistribution affects the equilibrium price, altering risk premia, liquidity costs, and the degree of informational asymmetry. As a consequence, closures alter both the means and variances of returns. The article demonstrates that closures can generate a variety of mean and variance effects, including those that mirror the empirical phenomena.