The Research On Liquidity Risk Based On Noise Trading

As argued by Amihud and Mendelson(1988), Liquidity is all of the market. Not only is the kernel of the research on financial market microstructure, the subject about liquidity also plays a crucial role in the domain of the research on asset pricing. Furthermore, the issuing of the liquidity premium theory covered the shortage of the traditional Capital Asset Pricing Model, and makes scholars pay more attention on the research on liquidity risk and liquidity premium phenomenon. As stock market in China develops, liquidity risk is emerging gradually, and makes it imperative to engage in the research on market liquidity.This essay simply tries to do some research on liquidity risk by means of classical theoretical model in behavioral finance. This essay, combining the research on liquidity risk with some elements in behavioral finance such as heterogeneous beliefs and cognitive bias of noise traders, deduces a price impact of noise trading model based on heterogeneous beliefs, which is used to explain the effect of investors'behavior on the formation of liquidity risk and the liquidity premium. The model providing in chapter three shows that influenced by cognitive bias (sentiment) of noise traders, liquidity risk is in direct proportion to the risk aversion degree of traders, the variance of noise traders'misperceptions of the expected return of the risky asset and the proportion of noise traders in market participants, and in inverse proportion to the total number of market participants. Thus, it can come to the important conclusion in this essay that noise trading is the origin of liquidity risk and liquidity premium.Due to the particularity of the model built in this essay, it is not practical to do empirical works using actual data. Therefore, computer simulation is adopted instead referring to Artificial Stock Market. As a result, the conclusion mentioned above is confirmed by examining the effect of the total number of market participants and the proportion of noise traders on liquidity risk and the relationship between the liquidity risk, which is represented by the price impact coefficient of noise trading, and the expected return of the risky asset.The conclusion indicates that our securities supervision department should actively develop and enlarge the size of institution investors. At the same time, it should make great efforts to reinforce the systemic education of individual investors about investment and financing so as to enhance the investment level and the risk management consciousness of individual investors.