Commonality in Liquidity in Emerging Markets: Evidence from the Chinese Stock Market

Abstract

This study examines to what extent liquidity is determined by common underlying factors in an emerging market that has adopted an order-driven trading system. Using China as a case for the study, we select a broad sample of stocks from two separate Chinese stock exchanges to measure and analyse market-wide movements in liquidity. Evidence found in this study confirms that commonality is present in emerging markets, and seems significant and pervasive. Its existence is robust to the influences of size, industry, and up and down markets effects. In parallel to a market-wide component, we find in the commonality construct an industrial component. Liquidity of large firms' stocks is found to be more likely to move with market liquidity. We also find that fund managers 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. These findings about the Chinese stock market provide useful pointers for understanding commonality in emerging economies and shed critical light on a new dimension of the working of emerging markets.