Liquidity, Liquidity Measure And Expected Return

Liquidity and liquidity risk are the important factors affecting asset prices and returns, The research about the relationship between liquidity and asset pricing is very important not only for theory but also for the industry field. In order to study the relationship between the liquidity and the asset pricing, we must initially measure the individual stock's liquidity and the market's liquidity effectively. Based on the data of the A-share market from 1997.1 to 2005.12, using the turnover, the price impact index, ILLIQ, given by Amihud(2002) and the Pastor-Stambaugh liquidity measurement as measurement of liquidity, this paper make an empirical analysis to study whether there is a Liquidity Premium on the individual stock and the whole market, compares the efficiency and information added ability between the turnover and ILLIQ as a individual stock's liquidity measure, repeat the two studies in the different market condition(in the bull and bear market) furthermore. The conclusions are:1. There is liquidity premium in China A-share stock market, and a significantly positive relationship between the expected stock returns and their illiquidity. The magnitude of liquidity premium is highly related to the size and(or) value risk factors of the stock market documented by Fama and French, but not related to market risk.2. Furthermore, in bear market, turnover, a liquidity measurement based on the trading activity of stock, could document the relationship between illiquidity and the expected stock returns more efficiently than ILLIQ. In bull market, however, ILLIQ is a more accurate measurement than turnover to describe illiquidity of stocks and their expected stock returns3. There is a Market Liquidity Premium in the A-share market, that means the individual expected stock returns are negatively correlated with the unexpected market liquidity change. Furthermore, the market risk factor, size factor, value factor are the important factors affect the expected stock returnsThese results are robust in the bull market and bear market.