The Impact Of Liquidity And Trait Risk On Stock Returns

Liquidity and asset pricing is one of the hot topics in the study of thecurrent financial. As well as other financial assets，liquidity has a remarkableimpact on stock returns. Since the benefit of any kind of financial assets must beobtained by high liquidity of the market. Liquidity risk refers to the investors inthe market can’t trading at a reasonable price timely, which may lead to the riskof loss. The relationship between the liquidity risk and asset prices has been thehot issue in theory research, in domestic many literatures study about therelationship between liquidity and stock returns, but the study of stock liquidityrisk and liquidity premium is not mature, mainly concentrated in the measure ofliquidity from different angles or just add liquidity factor in asset pricing modelto observe its significance. The study of the liquidity of individual share isrelatively little research. Idiosyncratic risk is also a focus in the study of thecurrent financial scholars. What does mean of Idiosyncratic risk? If the marketis effective, all factors affecting stock returns can be pricing, the error term ofpricing model contains the corresponding items that cannot be explained,whichinfluence the factors of pricing, we call this term the idiosyncratic risk. In recentyears, many scholars has shown that, in equilibrium, the pricing is not only asystemic risk, idiosyncratic risk is also pricing. Idiosyncratic risk has significanteffects on stock returns. If the whole market volatility remained stable, thecorrelation between individual share will remain stable, thus individual sharevolatility will improve greatly. So far, the research about factors related to risk,specially the fluctuations of earnings or idiosyncratic risk is becomingincreasingly important. The roles played by idiosyncratic risk and liquidity indetermining stock returns have recently received a great deal of attention.However, recent empirical tests have not examined the interaction betweenthese two factors.This paper examines the interaction of liquidity, idiosyncraticrisk and return across time in determining stock returns. Overall, using daily data, we find that liquidity is relevant in determiningstock returns. Univariate tests show that stock returns have negative effects withliquidity. While idiosyncratic risk appears to play little or no role in stockreturns. When both liquidity and idiosyncratic risk are used to simultaneouslyexplain returns in CAPM, liquidity still have significant influence on stockreturns, and idiosyncratic risk still appears to play little or no role. But whenliquidity explain returns in Fama-French model, the significance of liquidityseems decreasing, and idiosyncratic risk still seems to play no role in stockreturns. When both liquidity and idiosyncratic risk are used to simultaneouslyexplain returns in Fama-French model, the result are the same.Which meanswhen liquidity and idiosyncratic risk are considered at the same time, one factoris not significantly decreasing the importance of the other factor. And inFama-French model, the RMRF factor, SMB factor, HML factor all havesignificant inlfuence on stock excess returns.