An Analysis Of The Impact Of Liquidity Risk On Stock Returns

Liquidity risk is one of the most important factors. Till year2012, most liquidity risk researches in China are focused only on China mainland stock market. However, as the burst of international financial crisis and the practice of Quantitative Easing Monetary Policy, the world liquidity level had suffered huge volatilities. And China mainland and Hong Kong stock markets have been experienced different liquidity risk changes as well as stock returns changes. Therefore, I researched Chinese stock return movements even in special market conditions comparing with Hong Kong stock return changes. It provides effective analyzing tools for investors to analyze the influential factors of stock returns by LCAPM (Liquidity-augmented Capital Asset Pricing Model). This paper analyzed A stock and H stock returns liquidity risk, and industry index returns liquidity risk as well.This research found that liquidity affects A stock return in huge amount, and the market beta affects A stock returns only among stocks with high market beta level. Even though there are differences with the liquidity risk influential channels among Finance, Public Utilities, Manufacture industry stocks, it is obvious that liquidity risk has a high impact to A stock returns. With the study of H stock return liquidity risk, H stock returns suffer less influences of liquidity and market beta than A stock returns. And there are less liquidity risk in H stock returns comparing to A stock returns.In the analysis of industry index returns liquidity risk, it is proved that Hong Kong market industry index returns suffer less liquidity risk than A stock market’s. Especially in Finance industry, A stock market has huge impact of liquidity risk revealed in the significance of all liquidity risk betas, while Hong Kong market only receives the influence of liquidity variable.At last, I analyzed the movement of industry index returns and its betas in A stock and Hong Kong stock market, to find out the exact impacts of liquidity risk to stock returns in real stock return movements. This paper shows that stock returns moves with significant betas better than insignificant betas. Then, by observing the movement of the betas and returns, it shows that there are sudden changes of betas and stock return and the differences of the causation of liquidity risk in A stock and Hong Kong market. A stock market liquidity risk is changed by the macroeconomic policy of the mainland China, however, Hong Kong stock market liquidity risk is changed by international liquidity shocks.As a result, there are significant differences of liquidity risk impacts in A stock and Hong Kong stock markets. These differences reveal the different financial market conditions of mainland China and Hong Kong. In LCAPM regression, A stock returns receives more influences of liquidity risk than Hong Kong stock returns. These different liquidity risk impacts tell us that it is not related between financial market openness and liquidity risk influences. This paper shows the best method to avoid liquidity risk to reach high level market maturity.