Commonality in liquidity : evidence from the Chinese stock market

• Main Author: Zheng, Xinwei
• Published: Durham University 2008
• Subjects: 332.64251
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.478876

The thesis examines the commonality in liquidity on the Chinese stock market from three different aspects. Using a proprietary set of data from China, I confirm that commonality in liquidity is present in China and seems more significant and pervasive than that of similar markets. Its existence is robust to the influences of the size, industry, and up and down markets effects. In parallel to a market-wide component, I find in the commonality construct an industrial component. Liquidity of large firms' stocks is found to be more likely to move with market liquidity. I also find that Chinese investors exhibit herding behaviour in their liquidity management. In the face of shocks to market liquidity, Chinese market participants tend to adjust both the spread and the depth. In a down market, market liquidity moves more widely and commonality in liquidity becomes more significant. Sources of commonality in liquidity in China are multitude. Using the number of trades as an indicator of informed trading, results suggest a common component in asymmetric information at the market and industry levels. Following the market conditions approach, I find that commonality in liquidity is determined by common factors in market volatility and market liquidity. But common factors in interest rate and market return are insignificant. In addition, market return, volatility, and share turnover can significantly influence liquidity. Thus, market liquidity is found to be resilient to both market-level and economy-v-;ide shocks. Inflation and monetary policy are particularly important in explaining liquidity'S variation. Existence of commonality in liquidity has found implications for asset pricing. The impacts of commonality in liquidity showed the cross-section of average returns in China derived from a priced liquidity risk factor. In a dynamic asset pricing model, aggregate liquidity is found to be a priced risk factor and a significant liquidity risk premium is present on the Chinese stock market when dispersing average returns in the portfolios and adopting relevant measure of market-wide illiquidity.