Capital Controls, Level Of Liquidity And Stock Returns In Malaysia

This paper examines whether the relationship between the level of liquidity and stock returns during this period in Bursa Malaysia (KLSE) are affected by the implementation of capital controls by the Malaysian government following the 1997 Asian financial crisis. The turnover ratio is used as a measure of the level of liquidity, with the control variables being beta, size, book-to-market ratio, and momentum. The examination of the interactions between beta, size, book-to-market, momentum, and turnover ratio with capital controls demonstrated that the impact of size became smaller, the impact of book-to-market became more positive, and the impact of the level of liquidity became larger after capital control implementation. Beta does not have a significant impact on returns, which remained unchanged even after the inclusion of the capital controls interaction term. The impact of two out of the three momentum terms became more positive. The reliability of the results was confirmed and verified through several robustness checks. The impact of the turnover ratio on returns or the mediating effect of capital controls on the impact of the turnover ratio on returns was not altered by the exclusion of the January data. The tests provide evidence of a nonlinear relationship between the level of liquidity and stock returns even with the inclusion of the capital controls interaction terms. When the level of liquidity is high, its impact on returns becomes significantly greater. In addition, the study demonstrates that while a high level of liquidity may contribute favorably to stock returns, the variation in the level of liquidity has a negative impact on returns, which becomes more negative following the implementation of capital controls.