Abstract
This study investigates the impact of liquidity risk on stock returns of 149 firms in the industrial products and services sectors of Bursa Malaysia from January 2000 to December 2018 with a monthly frequency dataset. This study employed the two-stage standard procedures in asset pricing to estimate the significant effect of liquidity risk on industrial products and services stock returns. The results show that the investors require liquidity premium for stocks whose illiquidity co-moves with market illiquidity and market return while shifting their investment to liquid stocks when the market becomes illiquid, thus positive premium for stocks whose return is higher during the illiquid market. It suggests that two liquidity risks, namely commonality in liquidity and the covariances between stock illiquidity and market returns, and aggregate liquidity risk explain the cross-sectional returns variations across stocks in the industrial products and services sector, thus partly support the LCAPM model. We provide evidence on the important role of liquidity risks on the cross-sectional industrial products and services stock returns in Bursa Malaysia in the LCAPM framework. The findings of this study may be useful for investment decision-making and portfolio allocation strategy under the liquid and illiquid securities conditions. For policymakers, understanding the impact of liquidity risks on stock returns for the industrial products and services sectors may help enhance market liquidity for economic growth. Therefore, our findings contribute to the practical and policy implications.
Highlights
The Capital asset pricing model (CAPM) developed by Sharpe [55], Lintner [41], and Mossin [44] is the well-known and widely employed asset pricing model in financial theory [42]
This research analyzed the impact of liquidity risks on stock returns of firms in the industrial products and services sectors of Bursa Malaysia, using the liquidity-adjusted capital asset pricing model (LCAPM) framework of Acharya and Pedersen [1]
The four betas estimated in the first stage were used in the second stage of cross-sectional regression under different LCAPM specifications to understand its significant effect on stock returns in Malaysia’s industrial products and services sector from 2004:12 to 2018:12
Summary
The CAPM developed by Sharpe [55], Lintner [41], and Mossin [44] is the well-known and widely employed asset pricing model in financial theory [42]. It describes how it measures risk and the relationship between risk and expected returns. Market microstructure explains how investor’s behavior is translated into volume and prices under specific trading rules [9, 21, 47].
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