Illiquidity And Stock Pricing: Cross-Sectional Effects And Time-Series Effects

China’s stock market has been growing in recent years under a continuous turbulent environment.With the establishment of the Beijing Stock Exchange in2021,China’s stock market has entered a new phase where the rationality of stock pricing and capital flow determines whether it is beneficial to the development of the national economy and needs to be highly concerned and effectively regulated.Liquidity is crucial to a market,and so is the stock market.Liquidity can be used as a factor that has an impact on stock returns,and we may want to study the relationship between illiquidity and stock pricing from another perspective.Illiquidity,the opposite concept of liquidity,is used as a measure of the degree of liquidity in a market;the greater the illiquidity,the more illiquid the market is,and the less illiquid,the more liquid the market is.According to Kyle’s(1985)definition,the greater the impact of a given trading volume on the stock price,the less liquid it is and the greater the illiquidity,illiquidity can also be measured by the bid-ask quoted spread,the greater the quoted spread,the higher the level of illiquidity.Among them,Amihud(2002)proposed the illiquidity index ILLIQ,which is widely cited in the academic community but is also somewhat controversial.In this paper,we construct the illiquidity indicator ILLIQ to measure liquidity using a sample of CSI 300 constituent stocks for a total of 62 months of market data from January 1,2014-February 2019,and employ the Fama-Macbeth(1973)approach by estimating monthly cross-sectional regressions of stock returns for the Amihud illiquidity indicator and common control variables,and then by constructing monthly average data for the portfolio to investigate the effect of illiquidity and stock expected returns over the time series,and then finally by decomposing the Amihud illiquidity indicator to investigate the drivers of the effect of illiquidity on stock expected returns by adding its component parts to the regression.There are the following findings: first,illiquidity is significantly and positively correlated with stock expected excess returns during the sample period,i.e.,the greater the illiquidity,the greater the stock expected excess returns;second,the expected illiquidity is insignificantly correlated with stock excess returns,and unanticipated illiquidity is negatively correlated with stock excess returns,as can be obtained in the time series test,i.e.,there is no time series on the "Ammihud" premium;third,by adding the Amihud illiquidity indicator decomposition component to the cross-sectional regression,we obtain that its impact on stock expected excess return is mainly driven by trading volume,indicating that its impact on stock expected return may be compensated by the illiquidity brought by the volume.The research in this paper studies the impact of illiquidity on stock expected returns in the Chinese stock market from a practical perspective,with the following innovations in research methods and contents: first,the method of Amihud is used to construct illiquidity indicators using the market data of the Chinese stock market and to analyze them with stock pricing;second,the illiquidity indicators are decomposed and different components are added to the model for regression,so as to obtain the mechanism of the impact of illiquidity on expected stock returns;third,the cross-sectional regression analysis adopts the Fama-Macbech regression analysis,and in the model setting,the short-term reversal control factor and the momentum effect control factor are added,which can make the impact of illiquidity on the expected excess stock returns more credible.