Uncertainty Elasticity of Liquidity and the Associated Premium of China's A-Shares

37 Pages Posted: 15 Feb 2018

See all articles by Ping-Wen Sun

Ping-Wen Sun

Minjiang University - Newhuadu Business School

Bin Yu

Jiangxi University of Finance and Economics

Date Written: July 4, 2017

Abstract

We investigate what determines a stock’s uncertainty elasticity of liquidity (UEL: the change in the individual stock’s liquidity given the change in the market return volatility) and whether UEL is priced for China’s A-shares. We find stocks with higher UEL are associated with lower share price, smaller market capitalization, higher illiquidity ratio, lower institutional ownership, and fewer shareholders. Furthermore, those stocks have higher market risk and liquidity risk according to Acharya and Pedersen (2005)’s liquidity capital asset pricing model. From May 2004 to April 2017, our results show that the highest UEL equally-weighted decile portfolio significantly outperforms the lowest UEL equally-weighted decile portfolio by 1.19% per month and the risk adjusted UEL premium by the 6-factor (Fama and French (2015) five factor plus a momentum factor) model remains significant at 0.28% per month. Moreover, we find the UEL premium matters more for illiquid stocks with less investor attention. Finally, we find UEL fails to subsume the explanatory power of liquidity risk on cross-sectional stock returns and liquidity commonality is the most important dimension of liquidity risk for China’s A-shares.

Keywords: market uncertainty, liquidity, liquidity risk, stock returns, volatility, A-share

JEL Classification: G12, G15

Suggested Citation

Sun, Ping-Wen and Yu, Bin, Uncertainty Elasticity of Liquidity and the Associated Premium of China's A-Shares (July 4, 2017). Available at SSRN: https://ssrn.com/abstract=3118163 or http://dx.doi.org/10.2139/ssrn.3118163

Ping-Wen Sun (Contact Author)

Minjiang University - Newhuadu Business School ( email )

Fujian
China

Bin Yu

Jiangxi University of Finance and Economics ( email )

South Lushan Road
Nanchang, Jiangxi 330013
China

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