Asset Pricing And Liquidity Risk

Liquidity risk is the important risk in the stock market meaning that investors can not trade stocks with low cost in time in a general way. Whether and how liquidity risk affects the expected return is always a hot point in financial economics.Amihud and Mendelson (1986) had done some research in this field firstly , who studied from the microcosmic trading cost and induced by using bid-ask spread as the measurement method of liquidity .They drew a conclusion that the liquidity of the asset was an important influence factor of asset pricing and the asset with lower liquidity had higher return and the asset with higher liquidity had lower return. In capital market, the market does not compensate investors for unsystematic risk which can be eliminated by investment decentralization and only systematic risk that can not be eliminated by investment decentralization affects expected returns. Under the existing price level, the traders need to pay other uncertain transaction cost except the fixed cost if they want to exchange securities for cash. Uncertain transaction cost increases the illiquidity of the stock and the illiquidity affects the price of the stock which makes traditional Capital Asset Pricing Model to have some limitation.This paper analyses some factors such as the market characters of liquidity risk, method of measurement and the market policy first, and then point out that the capital asset pricing should indicate the effect of liquidity risk and expected returns. We analysis five sector indices (industry, commerce, public utilities, real estate and integration) as five portfolios in Shanghai Stock Market based on Liquidity-Adjusted Capital Asset Pricing Model in time series. Our empirical study finds that there is systematic risk in Shanghai Stock Market and liquidity risk is priced but not significant. Because of collinearity of measures of liquidity risk, it makes it hard to empirically distinguish the separate effects the individual liquidity betas and pricing. Our study suggests that systematic risk and liquidity risk are not priced correctly because Chinese stock market is always affected by policy when we study the two sub-samples which are divided by different market state. Our study suggests that systematic risk and liquidity risk is not priced correctly because Chinese stock market is always affected by policy when we study the two sub-samples which are divided by different market state. At last, based on empirical results and research purposes about liquidity risk and asset pricing, we put forward some policy suggestions about the development of the stock market.