Research On The Liquidity Premium And Liquidity Risk Premium Of Chinese Open-end Fund

O ’Hara(2003), a well-known scholar, pointed out that price discovery andliquidity were two fundamental function of financial market. However, the liquidityproblem has not been given sufficient attention until the eighties of the last century.Good liquidity doesn’t always exist in financial market, in these crises, marketliquidity suddenly disappeared, transaction c osts increased significantly, securitiesprice declined sharply and other reactions leading to market failure. Even moreserious is that the financial market crisis is contagious, it can infect from one marketto another which threat the security and stability of the entire financial system,thereby affecting the normal operation of the real economy.Nowaday, the fund industry, banking, securities and insurance have become fourmajor pillars of modern financial system. Within the fund industry, open-end fundsare the mainstream, and they have unavoidable liquidity risks owing to theircontractual characteristics, product properties and operational features. Thus, thispaper examines evolution laws of liquidity risks of Chinese open-end funds and theireffects upon asset pricing based on financial market microstructure theories, in hopeof providing references for investors to make rational investment and for supervisiondepartments of securities to maintain market liquidity and prevent liquidity crisis.In this paper, liquidity of open-end funds was measured by Amihud illiquidityratio. Besides, existence of liquidity premiums and liquidity risk premium of Chineseopen-end funds were empirically investigated by Fama-Macbeth cross-sectionalregression model and LCAPM(Liquidity-adjusted Capital Asset Pricing Model).30representative open-end funds were selected as samples and the entire period wasdivided into bull and bear markets, so as to examine if liquidity premiums or liquidityrisk premiums existed under different market situations and their features.The research findings suggested that there were significant market risk premiumsin the whole period and bull market, whereas such premiums didn t exist in the bearmarket. Liquidity premiums didn t exist in the entire period and bull market, butwere significant in the bear market. Furthermore, no significant premiums wereobserved in liquidity risks no matter in the entire period or bear/bull market. Hence,there are no significant liquidity risk premiums for Chinese market of open-end funds.