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Illiquidity and asset pricing in the Chinese stock market

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  • Maobin Wang
  • Dongmin Kong
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    Abstract

    Purpose–Since illiquidity risk is one of the most important pricing factors of assets, the aim of this paper is to evaluate the suitability of proxies of illiquidity prevalent in the asset pricing literature and their explanatory power in asset pricing tests. Design/methodology/approach–Using the available high-frequency intra-day data, the paper constructs some proxies of illiquidity as benchmarks and then evaluates proxies of illiquidity based on inter-day data. Findings–The empirical results provide convincing evidence that turnover is the most suitable proxy of illiquidity in the Chinese stock market. It is not only hghly related to intra-day data-based proxies of illiquidity but also completely superior to other measures of illiquidity in asset pricing tests. Originality/value–First, the paper applies illiquidity measurements from microstructure theory and the available high-frequency data, and examines the suitability of illiquidity proxies in asset pricing literature in the Chinese stock market. Rational basics are provided to test the applicability of illiquidity measures in the Chinese stock market. Second, the paper introduces illiquidity proxies into asset pricing models to extend their explanatory power. The paper's results may help researchers to select illiquidity proxies more cautiously.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal China Finance Review International.

    Volume (Year): 1 (2010)
    Issue (Month): 1 (December)
    Pages: 57-77

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    Handle: RePEc:eme:cfripp:v:1:y:2010:i:1:p:57-77

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    Related research

    Keywords: Asset valuation; China; Securities; Stock markets;

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    References

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    1. Pástor, Luboš & Stambaugh, Robert F, 2002. "Liquidity Risk and Expected Stock Returns," CEPR Discussion Papers 3494, C.E.P.R. Discussion Papers.
    2. Bessembinder, Hendrik & Kaufman, Herbert M., 1997. "A Comparison of Trade Execution Costs for NYSE and NASDAQ-Listed Stocks," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 32(03), pages 287-310, September.
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    7. Lee, Charles M C & Ready, Mark J, 1991. " Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-46, June.
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    11. Yakov Amihud & Haim Mendelson & Beni Lauterbach, 1997. "Market Microstructure and Securities Values: Evidence from the Tel Aviv Stock Exchange," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-004, New York University, Leonard N. Stern School of Business-.
    12. Brennan, Michael J. & Subrahmanyam, Avanidhar, 1996. "Market microstructure and asset pricing: On the compensation for illiquidity in stock returns," Journal of Financial Economics, Elsevier, vol. 41(3), pages 441-464, July.
    13. Chordia, Tarun & Subrahmanyam, Avanidhar & Anshuman, V. Ravi, 2001. "Trading activity and expected stock returns," Journal of Financial Economics, Elsevier, vol. 59(1), pages 3-32, January.
    14. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    15. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    16. Brennan, Michael J. & Subrahmanyam, Avanidhar, 1995. "Investment analysis and price formation in securities markets," Journal of Financial Economics, Elsevier, vol. 38(3), pages 361-381, July.
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