IS SYSTEMATIC LIQUIDITY RISK PRICED IN TAIWAN EMERGING STOCK MARKET

Abstract

The Taiwan Emerging Stock Market (TESM) is a decentralized, over-the-counter (OTC) broker-dealer market, in which trading information is more asymmetric and the stocks are expected to suffer more liquidity risks compared with exchange-listed markets. We adopt firm-specific liquidity discount and Amihud illiquidity to examine whether systematic liquidity risk is priced in the returns of TESM stocks. Amihud illiquidity is relevant to macroeconomy fluctuations, while liquidity discount reflects more firm-specific fundamentals. Our empirical results indicate (1) Amihud illiquidity reveals higher systematic liquidity risk for the early period of TESM, and liquidity discount highly reflects the liquidity risk for the 2008 financial crisis; (2) systematic liquidity risk measured by liquidity discount is a critical factor associated with the expected returns of TESM stocks. Investors require higher compensation on more illiquid TESM stocks; and (3) systematic liquidity risk measured by liquidity discount is priced in the TESM stock returns from 2004 through 2008. This phenomenon is also found between 2009 and 2013. Compared with the result of 2004–2008, pricing systematic liquidity risk is less significant during the period 2009- 2013.