Shanghai Stock Market Liquidity Premium Empirical Research

Liquidity is the quality of an asset being readily convertible into other assets at a reasonable price and transaction costs. High liquidity is vital to any securities market. Whether or not liquidity affects the price of assets is a hot topic in capital market researches and in investors' decision-making theories. Theoretically, there is liquidity premium in the stock market, that is to say, to compensate liquidity risk, stocks with low liquidity would sell at a lower price and they would have higher return than higher liquidity stocks.The paper chooses the stocks that begin trading before 1998 in Shanghai A stock market as research samples, 248 stock trade from January of 1998 to this period of December of 2004 was selected as the research object. This dissertation is an empirical study on liquidity premium---the relationship between liquidity and expected returns—in Chinese stock market on the basis of stock market liquidity premium theories and panel data regression model.The main outcomes and conclusions of this dissertation are as follows:1. The actuality of liquidity premium in Chinese stock market is studied deeply and thoroughly on the basis of the data of individual stocks. Different conclusions are drawn from three different measures of liquidity, which means that the choice of measures of liquidity has an evident impact on researches on the existence of stock market liquidity premium. When turnover ratio and Amivest liquidity ratio act as measures of liquidity, the phenomenon of liquidity premium in Chinese stock market does exist, which shows that tumover ratio and Amivest Liquidity Ratio are essential indicators that have a fundamental influence on the expected remms of stocks. When illiquidity is used as the measure of liquidity, there is no liquidity premium in Chinese stock market. In addition, whether turnover ratio or Amivest Liquidity Ratio are chosen as measures of liquidity, the test result on the cause of liquidity premium in Chinese stock market demonstrates that the expected return is the multi-sectional linear and total convex function of the turnover ratio.When turnover ratio and Amivest liquidity ratio act as measures of liquidity, empirical models on the effects of market liquidity on excess market rate of return and the rate return of individual stock are established, and the models and the effects of their explanatory variables on market liquidity are demonstrated. Based on the two hypothesis, this paper arrives the conclusions: The positive effects of expected and unexpected market liquidity on excess market rate of return and the rate return of individual stock are existing. Whether market or individual stock, the result of model regression is the same of two measures of liquidity are used in calaclating market liquidity and portfolio rate of return. Also, the empirical results reveal that there are considerable substitution effects of liquidity in shanghai stock market.2. According to the data of individual stocks from different periods and the data during policy changes and occurrence of important events, and different market situations, at the same time built on portfolio data, the following conclusions are drawn from the empirical study of the impact of the measures of liquidity in particular turnover ratio on expected returns of stocks:Under different market situations:(1) The test result with turnover ratio as the measure of liquidity reveals that there is stable liquidity premium in Chinese stock market in the three subsample periods. Moreover, the effects of turnover ratio on expected retums of stocks are more significant in bull market periods.(2) The test result with Amivest Liquidity Ratio as the measure of liquidity reveals that there is liquidity premium in Chinese stock market during bull and bear market periods. But there is no liquidity premium in Chinese stock market during fluctuating market periods. Therefore, during the entire sample period, Amivest Liquidity Ratio as the measure of liquidity has an effect on expected retums of stocks and there is liquidity premium in Chinese stock market but it is not stable.When policies change and important events occur:(1) The test result with turnover ratio as the measure of liquidity reveals that policy changes and the occurrence of important events have little impact on the stability of liquidity premium in Chinese stock market. Whether there are policy changes or important events or not, the coefficient mean is always negative. On the other hand, the t value is always insignificant, which means that the choice of sample periods affects the existence of liquidity premium in Chinese stock market.(2) The test result with Amivest Liquidity Ratio as the measure of liquidity reveals that whether there are policy changes and important events or not, there is stable liquidity premium in Chinese stock market, and when there are policy changes or important events, liquidity premium in Chinese stock market is more significant.In terms of portfolio data:This paper selects turnover ratio as the measure of liquidity to test with portfolio data whether there is liquidity premium in Chinese stock market because turnover ratio reinforces the significance of liquidity premium in Chinese stock market. The test result reveals that the coefficient mean of portfolio turnover ratio is usually negative but the t value is not significant, which is contradictory to the theory of liquidity premium and the analysis based on the data of individual stocks.In general, in Chinese stock market, expected returns and turnover ratio (a measure of liquidity) is generally inversely related. That is, in most cases, there is strong stability of liquidity premium in Chinese stock market. But the stability of liquidity premium in Chinese stock market will be undermined by such special factors as policy changes or important events, different market situations and analyses based on the data of individual stocks or portfolio data.3. An empirical study on the "size effect" and "value effect" of liquidity premium in Chinese stock market based on the data of individual stocks shows:(1) As far as the entire stock market is concerned, The test model with turnover ratio and Amivest Liquidity Ratio as the measure of liquidity reveals that there is "size effect" and "value effect" of liquidity premium in Chinese stock market. The test model with illiquidity as the measure of liquidity reveals that there is no "size effect" and "value effect" of liquidity premium in Chinese stock market. The conclusion is that different measures of liquidity have significant effects on the "size effect" and "value effect" of liquidity premium in Chinese stock market.(2) As far as the stock market of different industries is concerned, The test model with turnover ratio, Amivest Liquidity Ratio and illiquidity as the measures of liquidity all reveals that there is no "size effect" and "value effect" of liquidity premium in Chinese stock market.4. An empirical study on the "month effect" of liquidity premium in Chinese stock market based on the data of individual stocks shows: there is no "month effect" in each month of the sample period with turnover ratio and Amivest Liquidity Ratio as the measures of liquidity.The main innovations of this paper are as follows:1. As far as research methodology is concerned, this paper is mainly based on the fixed effect model of panel data regression model to study stock market liquidity premium. This model has many advantages such as the increase of samples, the more accurate estimation values. In particular, the following models are established:(1) The fixed effect model of the panel data multi-factor regression model with liquidity measures as explanatory variables and expected returns as the explained variable is established to test the existence of stock market liquidity premium.(2) The fixed effect model of the panel data multi-factor regression model with the turnover ratio interacting-dummy variable as explanatory variables and expected returns as the explained variable is established to test the existent reason of stock market liquidity premium. Meanwhile, a slope dummy variable is formulated to test whether the size of companies has a significant effect on expected returns during the bull/bear market periods with June 2001 as the dividing point.(3) The fixed effect model of the panel data multi-factor regression model with the size effect (ratio of paper value and market value) as explanatory variables and expected returns as the explained variable is established to test the "size effect" ("ratio of paper value and market value")of stock market liquidity premium. Meanwhile, a slope dummy variable is formulated to test whether the size of companies(BM/EM) has a significant effect on expected returns during the bull/bear market periods with June 2001 as the dividing point.2. In contrast to most scholars from home and abroad who usually select one measure of liquidity to study stock market liquidity premium, given the reality of Chinese stock market and the availability of data, this paper chooses three measures of liquidity (turnover ratio, Amivest liquidity ratio and illiquidity) as the substitute variables of liquidity to see whether different measures of liquidity have significant impacts on the research of stock market liquidity premium.3. Three levels of the stock market are taken into consideration in the study of the existence of stock market liquidity premium, that is, the entire market, individual stocks, and stock portfolios. The existence of stock market liquidity premium is tested from the three levels respectively, which is helpful for investors especially institutional investors to understand the liquidity of the entire market and its changes and contributes to their decision-making.4. As far as different market situations, policy changes and the occurrence of important events is concerned, a panel data regression model is built on the data of individual stocks to study the stability of stock market liquidity premium; using turnover ratio as the measure of liquidity another panel data regression model is built on portfolio data to study the stability of stock market liquidity premium.5. The concepts of size effect, value effect and month effect are applied to the study of the effects of stock market liquidity premium. Meanwhile, given the existence of stock market liquidity premium, in terms of the entire market and individual industry, using three different liquidity measures, the existence of size effect and value effect is tested. Besides, given the existence of stock market liquidity premium, the existence of month effect is tested on the basis of turnover ration as the liquidity measure.