Liquidity and Expected Returns: Lessons From Emerging Markets

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 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 eliminated its impact.

Global versus Local Asset Pricing: A New Test of Market Integration

“…Conventional liquidity measures are difficult to calculate for emerging market stocks because of a lack of data on stock turnover. Lesmond (2005) and Bekaert, Harvey, and Lundblad (2007) therefore suggest the percentage of daily zero returns as an illiquidity proxy. The two-year period from July 1, 1998, to July 1, 2000, is used to calculate the percentage of zero returns, Z R j , and a stock liquidity proxy is defined as Liq j = ln(1 − Z R j ).…”

“…The finance literature has highlighted the role of stock liquidity for (short-term) stock price behavior, which suggests liquidity measures as additional regression controls. Following Bekaert, Harvey, and Lundblad (2007), I use again the liquidity proxy Liq j = ln(1 − Z R j ), where Z R j measures the percentage of days with zero stock return. Table 9 presents the augmented regression results.…”

Liquidity Cost Determinants in the Saudi Market

“…For in depth analysis, refer to Glosten and Harris, 1988, Chan K. and Lakonishok, 1995, among many others). 6 Since we use intraday minute data, we use the terms "trades" and "minutes" interchangeably. The quoted spread and effective spread report higher Rsquared at 27 and 22 percent, respectively.…”

“…6 The total price impact is calculated as the percentage return from five trades prior to the block trade to the block trade itself. The temporary price impact is calculated as the percentage return from the block trade to the fifth trade after the block trade.…”

“…For example, Amihud and Mendelson(1986) suggest that average liquidity is priced in the market while Pastor and Stambaugh (2003) find that security return sensitivity to market liquidity is a risk factor that is priced in the market. Amihud (2002), Bekaert et al, (2007) provide evidence that liquidity commoved with returns and can predict future returns.…”