Working Paper: NBER ID: w11413
Authors: Geert Bekaert; Campbell R. Harvey; Christian Lundblad
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.
Keywords: liquidity; expected returns; emerging markets
JEL Codes: G12; G14; G15; F30; F36; F02
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity measures (E41) | expected returns (G17) |
| unexpected liquidity shocks (F65) | contemporaneous return shocks (E32) |
| local market liquidity (G10) | expected returns (G17) |
| liquidity measures (E41) | transaction cost measures (D23) |
| liquidity (E41) | asset pricing (G19) |