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Liquidity Risks and Asset Pricing in Asian Stock Markets

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Liquidity Risks and Asset Pricing in Asian Stock Markets CAPITAL UNIVERSITY OF SCIENCE AND TECHNOLOGY, ISLAMABAD Liquidity Risks and Asset Pricing in Asian Stock Markets by Sadia Saeed A thesis submitted in partial fulfillment for the degree of Doctor of Philosophy in the Faculty of Management & Social Sciences Department of Management Sciences 2020 i Liquidity Risks and Asset Pricing in Asian Stock Markets By Sadia Saeed (PM131010) Dr.Biagio Simonetti , Associate Professor Universita del Sannio,Italy (Foreign Examiner 1) Dr.Zam Zuriyati Binti Mohammad, Assistant Professor University Tunku Abdul Rehman, Malaysia (Foreign Examiner 2) Dr. Arshad Hassan (Thesis Supervisor) Dr. Mueen Aizaz Zafar (Head, Department of Management Sciences) Dr. Arshad Hassan (Dean, Faculty of Management & Social Sciences) DEPARTMENT OF MANAGEMENT SCIENCES CAPITAL UNIVERSITY OF SCIENCE AND TECHNOLOGY ISLAMABAD 2020 ii Copyright c 2020 by Ms. Sadia Saeed All rights reserved. No part of this thesis may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, by any information storage and retrieval system without the prior written permission of the author. iii This thesis is dedicated to my beloved parents; To whom I owe my whole life. To my brother; Usman Saeed. To my sister Nadia Saeed vii List of Publications It is certified that following publication(s) have been made out of the research work that has been carried out for this thesis:- 1. Saeed, S., & Hassan, A. (2018). Inter-linkages between Liquidity and Stock Returns: An Empirical investigation through Panel Cointegration. Pakistan Journal of Commerce and Social Sciences (PJCSS), 12(2), 617-637. 2. Saeed, S.,& Hassan, A. Flight to Liquidity Risk, Multiple Liquidity Mea- sures and Equity Returns: Evidence from Pakistan Stock Exchange. Journal of Managerial Sciences (JMS), 11(4), 371-387. (Sadia Saeed) Registration No: PM131010 viii Acknowledgements To write a PhD thesis is a great challenge, it cannot be done without the support of supervisor, family, and friends. I would like to express my sincere appreciation to my supervisor Dr. Arshad Hassan; Professor of Finance and Dean of Capital university of science and technology. His suggestions and guidance throughout the thesis writing process helped me a lot in finalizing my work. I would like to thank my family especially mother for unconditionally compassionate and helpful throughout this journey. I would like to thank my siblings Nadia Saeed and Usman Saeed for their support and motivation. Last but not least, I would like to show my gratitude to my friends who have always encouraged me during this journey. (Sadia Saeed) Registration No: PM131010 ix Abstract The main purpose of doing the study is to examine the pricing of liquidity risks in Asian stock markets. The current study is a deductive study that empiri- cally tests the un- conditional version of liquidity adjusted capital asset pricing model developed by Acharya and Pedersen (2005). Multiple measures of liquid- ity including Amihud ratio, Amivest liquidity, Hui-Heubel liquidity ratio, Market efficiency coefficient, zero return, turnover and Roll estimator have been used for measuring multidimensional liquidity. The current study investigates the influ- ence of different types of liquidity risks including commonality in liquidity, Flight to liquidity and depressed wealth effect on equity returns of Asian stock markets including Japan, Pakistan, India, China and Thailand during 2005-2015. For the estimation of liquidity risks fixed effect panel regression has been employed in the study. Moreover liquidity adjusted Capital asset pricing model is based upon the developed market. The study attempts to investigate that this model can be or cannot be implied in its original form in emerging markets of Asia. The study also identifies the gray area in the model that needs to be addressed for its better implication in Asian emerging markets. The findings of the study support that individual and aggregate liquidity risks are priced in Asian stock markets and in- vestors are compensated for the wealth shocks and decline in stock and market liquidity. The flight to liquidity risks is least prominent in Asian stock market among the individual liquidity risks. The results of the study are also sensitive to liquidity measures selected for the study. Keywords: Emerging markets, Liquidity adjusted capital asset pricing model, Commonality in liquidity, Flight to liquidity, Depressed effect of wealth, Panel regression with fixed effects. JEL Classification: C12, C23, G11, G12, G15 Contents Author's Declarationv Plagiarism Undertaking vi List of Publications vii Acknowledgements viii Abstract ix List of Figures xvi List of Tables xviii Abbreviations xx 1 Introduction1 1.1 Theoretical Background........................1 1.1.1 Market Depth..........................2 1.1.2 Market Breadth/Width.....................2 1.1.3 Market Resilience........................3 1.1.4 Time...............................3 1.2 Problem Area for Research.......................5 1.3 Research Gap and its Rationale....................7 1.4 Research Questions...........................9 1.5 Objectives of the Study......................... 10 1.6 Significance of the Study........................ 10 1.7 Limitations of the Study........................ 12 1.8 Plan of the study............................ 13 2 Literature Review 14 2.1 Theoretical Review of Liquidity and Asset Pricing.......... 14 2.2 Market Microstructure Theory and Liquidity................................. 15 2.2.1 Market Liquidity Model Kerry (2008)............. 15 x xi 2.3 Market Micro Structure and Illiquidity Sources.................................. 17 2.3.1 Transaction Costs........................ 18 2.3.2 Asymmetric Information.................... 19 2.3.3 Search Frictions......................... 20 2.3.4 Inventory Risk......................... 20 2.4 Illiquidity Sources and Dimensions of Liquidity................................. 21 2.5 Empirical Literature on Liquidity and Asset Prices......... 23 2.5.1 Liquidity Risk.......................... 23 2.5.2 Trading Liquidity Risk in LCAPM Model.......... 23 2.5.2.1 Liquidity Level (LL)................. 24 2.5.2.2 Commonality in Liquidity (CL)........... 24 2.5.2.3 Flight to Liquidity (FL)............... 24 2.5.2.4 Depressed Effect of Wealth (DW).......... 24 2.6 Empirical Literature on Level of Liquidity.............. 27 2.7 Empirical Literature on Commonality in Liquidity................................. 32 2.8 Empirical Literature on Flight to Liquidity.............. 35 2.9 Empirical Literature on Depressed Wealth.............. 36 2.10 Empirical Literature Against Liquidity Premium................................. 37 2.11 Theoretical Framework......................... 38 2.11.1 Capital Asset Pricing Model.................. 39 2.11.2 Liquidity Adjusted Capital Asset Pricing Model....... 41 1 2.11.2.1 βi (Market Beta)................... 42 2 2.11.2.2 βi (Liquidity Commonality Beta).......... 43 3 2.11.2.3 βi (Flight to Liquidity Beta)............ 43 4 2.11.2.4 βi (Depressed Wealth Effect Beta)......... 44 5 2.11.2.5 βi (Aggregate Liquidity Beta)............ 44 6 2.11.2.6 βi (Total Systematic Risk)............. 44 2.12 Hypotheses............................... 46 3 Data Description and Methodology 49 3.1 Asian Stock Markets.......................... 49 3.2 Population................................ 50 3.3 Sample.................................. 50 3.3.1 Asian Stock Market Indexes.................. 51 3.4 Data................................... 52 3.4.1 Data Screening Procedure................... 52 3.5 Sample Size............................... 53 3.6 Liquidity Proxies for Measuring Multi-dimensional Concept of Liquidity................ 55 3.6.1 Price Impact Liquidity Measures............... 55 xii 3.6.2 Transaction Cost Liquidity Measures............. 57 3.6.3 Volume Based Liquidity Measures............... 59 3.6.4 Liquidity Measures Selected for the Study.......... 61 3.7 Construction of Variables........................ 61 3.7.1 Dependent Variables...................... 61 3.7.2 Independent Variables..................... 61 3.7.2.1 Illiquidity Proxies for Measuring Price Impact... 63 3.7.2.2 Illiquidity Proxies for Measuring Volume...... 65 3.7.3 Control Variables........................ 66 3.7.3.1 Firm Size....................... 66 3.7.3.2 Momentum...................... 66 3.8 Methodology for the Research..................... 66 3.8.1 Fitting Approach........................ 67 3.8.2 Autoregressive Process (AR2) for Innovation in Illiquidity............................ 67 3.8.3 Market Liquidity........................ 68 3.8.4 LCAPM Portfolio Beta Estimation.............. 68 3.8.4.1 Formation of Decile Portfolios............ 68 3.8.5 LCAPM Specifications..................... 70 3.8.6 Panel Regression with Fixed Effects.............. 70 4 Data Analysis and Discussion 72 4.1 Statistical Analysis of Pakistan.................... 72 4.1.1 Descriptive Statistics of Stock Returns and Illiquidity Proxies........................ 72 4.1.2 Correlation Matrix between Illiquidity Proxies........ 74 4.1.3 Innovations in Illiquidity Measures.............. 76 4.1.4 Market Liquidity........................ 78 4.1.5 Betas for Decile Portfolios................... 79 4.1.6 Results of Liquidity Adjusted Capital Asset Pricing Model for Pakistan........................... 83 4.1.6.1 Liquidity Adjusted Capital Asset Pricing Model Based on Amihud Ratio..................... 83 4.1.6.2 Liquidity Adjusted Asset Pricing
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