Aggregate Liquidity Premium and Cross-Sectional Returns: Evidence from China

43 Pages Posted: 12 Nov 2020 Last revised: 21 Sep 2021

See all articles by Cunfei Liao

Cunfei Liao

Nanjing University of Science and Technology - School of Economics and Management

Qianlin Luo

affiliation not provided to SSRN

Guohao Tang

Hunan University - College of Finance and Statistics

Date Written: March 12, 2020

Abstract

The Chinese stock market incurs huge illiquidity costs. Liquidity has different aspects but literature rarely measures it from an aggregate perspective. To capture liquidity along various dimensions and more consistently, we propose an aggregate liquidity premium with a partial least squares approach by aggregating information on 12 liquidity-related firm characteristics in the Chinese stock market. The aggregate liquidity predictor generates significantly higher expected stock returns than individual characteristics, remains robust to different information aggregation methods, and reflects the multidimensional feature of liquidity. Behavioral mispricing theory helps explain the aggregate liquidity premium because illiquidity limits arbitrage to correct mispricing. As liquidity is important and traditional factor models limitedly explain it, we develop a new-factor model to capture the aggregate liquidity premium. The aggregate liquidity premium in China indicates that policymakers should improve market liquidity.

Keywords: Aggregate Liquidity Premium, Information Aggregation, Partial Least Squares, Mispricing, New-Factor Model

JEL Classification: G12, G14

Suggested Citation

Liao, Cunfei and Luo, Qianlin and Tang, Guohao, Aggregate Liquidity Premium and Cross-Sectional Returns: Evidence from China (March 12, 2020). Economic Modelling, Vol. 104, 2021, Available at SSRN: https://ssrn.com/abstract=3726881 or http://dx.doi.org/10.2139/ssrn.3726881

Cunfei Liao

Nanjing University of Science and Technology - School of Economics and Management ( email )

No.200 Xiao Lingwei Street
Nanjing, Jiangsu 210094
China

Qianlin Luo

affiliation not provided to SSRN

Guohao Tang (Contact Author)

Hunan University - College of Finance and Statistics ( email )

Lushan Road (S), Yuelu District
Changsha, Hunan 410006
China

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
75
Abstract Views
432
Rank
478,810
PlumX Metrics