An investigation into the role of liquidity in asset pricing: Australian evidence
Chan, Howard W; Faff, Robert W
In the context of a cross-sectional regression framework, we explore whether liquidity is priced in an Australian setting, using monthly data over the period 1990 to 1999. Our major findings are as follows. First, we find that liquidity (as proxied by turnover) is negatively related to stock returns. Moreover, the importance of turnover persists even after controlling for book-to-market, size, stock beta and momentum. Second, we find that momentum is positively related to stock returns, with the momentum effect much stronger in our latter subperiod, 1995 to 1999. Third, the role of turnover (liquidity) in asset pricing though related to momentum is separate from it. That is, turnover is not simply capturing the momentum effect documented in the literature – rather, turnover seems to be an adequate proxy for liquidity. Finally, we find a non-linearity related to the size factor for the full sample period but for the liquidity factor the non-linearity is found only for the subperiod 1990 to 1994.
Keywords: Asset pricing; liquidity