Authors: Md Hamid Uddin and Won Kie Ann
Negative relationship between stock’s return and its liquidity suggests that illiquid stocks are riskier than liquid stocks hence illiquid stocks should earn more return. Researchers subsequently considered liquidity as another variable for asset pricing when they found commonality in liquidity. Earlier studies tested stock and market liquidities independently.
We therefore further test the relationship of stock’s return with its liquidity relative to market-wide liquidity by a relative measure linking the individual liquidity with market-wide liquidity.
Results confirm the negative relationship between stock’s return and liquidity, but the relationship is non-linear and the relative measure of liquidity complements the liquidity measures used in prior studies.
We find that fluctuations in relative liquidity do not have positive effect on stock return, raising a question whether variability in liquidity captures liquidity risk.
Key Words: Stock, Liquidity, Relative Liquidity, Risk, and Return.
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