An Empirical Study Of China's Stock Market Liquidity Premium

Liquidity is one of the most important characteristics of financial assets. According to the liquidity premium theory, illiquid financial asset will earn higher returns. By using the revised-Amivest ratio and illiquidity indicator, author studied the relationship between liquidity and returns for individual stocks in Shanghai and Shenzhen Exchange. The paper points out, with either revised-Amivest ratio or illiquidity indicator, the time series test shows a significant positive relation between liquidity and returns during the period from 1999 to 2004, which is inconsistent with the theory. The cross-section series test tells the same story except the test in Shanghai Exchange with the illiquidity indicator, which shows no stable relationship between the two. The cross-section series test also shows a significant positive relation between the firm size and returns, and a negative relation between BM ratio and returns, which is still against the expected"small firm effect"and"BM ratio effect".