Liquidity Variation And Cross-Section Stock Return

In 1968, Demsetz published the paper "transaction costs", it marks the birth of the securities market microstructure theory, after that, there are a lot of research on liquidity based on market microstructure. One of the earliest study is the research of Amihud and Mendelson in 1986, they deduced the relationship between expected returns and bid-ask spread model, put forward the liquidity premium theory creatively, namely, the liquidity of the assets is an important impact factor of asset pricing, low liquidity expected high stock return and high liquidity expected low stock return. Investors are willing to choose stock who has a high liquidity and low transaction cost, so the illiquidity premium will be embodied in every kind of asset prices.However, the liquidity of assets is not constant, but change over time. Many studies have shown that liquidity changes over time, and Bali et al. (2012) show that liquidity shocks can predict stock return and long-short portfolios sorted on liquidity shocks generates significant returns per month that are robust after controlling for risk factors and stock characteristics. In addition, Fang-jian Fu et al. (2013) show that the month-to-month liquidity change predicts the cross-sectional stock returns in the following month and the results are not explained by other cross-sectional return determinants.In view of our country, there is no research on liquidity variation and expected stock return. In this paper, we choose stock turnover as a proxy indicator of liquidity to explore the relationship between liquidity variations and expected stock return.The main content of this article is as follows:First of all, based on the data of Shanghai Stock Exchange’s A-stock, we explore China’s A-stock market liquidity and the liquidity variation.Secondly, we use two methods:portfolio sorting approach and cross-sectional regression to check the expect power of liquidity variation.Thirdly, we use some firm level characteristics to find out whether the predictive power of liquidity variation will be weaken after controlling these risk factors.Finally, we examine whether the relation exhibits any asymmetric pattern between turnover increases and decreases.The research results show that the liquidity variation has the ability to predict stock returns, and its predictive ability will not be affected by other return predictor. The prediction ability of turnover increase is superior to ability of turnover decrease, but the predictive ability is both significant. Our study provides new information for investors to choose portfolio.