Liquidity and Expected Returns: Lessons from Emerging Markets

56 Pages Posted: 3 Aug 2003

See all articles by Geert Bekaert

Geert Bekaert

Columbia Business School - Finance and Economics

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative

Christian T. Lundblad

University of North Carolina Kenan-Flagler Business School

Multiple version iconThere are 4 versions of this paper

Date Written: June 2006

Abstract

Given the cross-sectional and temporal variation in their liquidity, emerging equity markets provide an ideal setting to examine the impact of liquidity on expected returns. Our main liquidity measure is a transformation of the proportion of zero daily firm returns, averaged over the month. We find that our liquidity measures significantly predict future returns, whereas alternative measures such as turnover do not. Consistent with liquidity being a priced factor, unexpected liquidity shocks are positively correlated with contemporaneous return shocks and negatively correlated with shocks to the dividend yield. We consider a simple asset pricing model with liquidity and the market portfolio as risk factors and transaction costs that are proportional to liquidity. The model differentiates between integrated and segmented countries and time periods. Our results suggest that local market liquidity is an important driver of expected returns in emerging markets, and that the liberalization process has not fully eliminated its impact.

Keywords: Liquidity, liquidity risk, asset pricing, emerging markets, market integration, market segmentation, liquidity risk factor, local liquidity, zero returns, bid-ask spread, price impact, liquidity measures

JEL Classification: G12, G14, G15, F30, F36, F02

Suggested Citation

Bekaert, Geert and Harvey, Campbell R. and Lundblad, Christian T., Liquidity and Expected Returns: Lessons from Emerging Markets (June 2006). AFA 2004 San Diego Meetings; EFA 2003 Annual Conference Paper No. 690. Available at SSRN: https://ssrn.com/abstract=424480 or http://dx.doi.org/10.2139/ssrn.424480

Geert Bekaert

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
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Campbell R. Harvey (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
Durham, NC 27701
United States

Christian T. Lundblad

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-8441 (Phone)

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