Liquidity and asset pricing: Evidence from the Chinese stock markets

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2021-LenceS-LiquidityAssetManuscript.pdf (650.36 KB)

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2022-01-01
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Lence, Sergio
Lence, Sergio H.
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© 2021 Elsevier Inc.
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Abstract
We introduce a novel two-factor model, incorporating market and liquidity factors, which outperforms the CAPM and Fama-French factor models when applied to stock market returns in Shanghai and Shenzhen over 2000-2019. We compute the liquidity factor as the return on a liquidity-mimicking portfolio, which we construct simultaneously using two measures of liquidity (one of them capturing liquidity’s trading-quantity dimension, and the other associated with its price-impact dimension). Unlike the CAPM and Fama-French factor models, the advocated two-factor model is able to account for numerous return anomalies, such as size, book-to-market ratio, earningsto- price ratio, cash-flow-to-price ratio, return-on-equity, and volatility. The model’s performance is similar when applied separately to the Shanghai and Shenzhen stock markets. Furthermore, it fares similarly over the 1994-2004 and 2005-2019 sub-periods. This result is somewhat surprising, because liquidity seems likely to have been substantially lower over 1994-2004, as the Chinese markets were noticeably smaller, and the critical market reform aimed at eliminating non-tradable shares by the end of 2006 did not occur until 2005.
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This is a manuscript of an article published as Zhang, Tianyang, and Sergio H. Lence. "Liquidity and asset pricing: Evidence from the Chinese stock markets." The North American Journal of Economics and Finance 59 (2022): 101557. doi:10.1016/j.najef.2021.101557. Posted with permission. This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 License.
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Chinese stock markets, Liquidity, Two-factor model, Size effect, Value effect, Return anomalies
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