Liquidity Risk and Expected Stock Returns in Korea: A New Approach

Authors


  • Acknowledgements: This work was supported by Hankuk University of Foreign Studies Research Fund of 2012. We are grateful to the editor and anonymous referees for constructive comments and suggestions.

Corresponding author: Changjun Lee, College of Business Administration, Hankuk University of Foreign Studies, 270 Imun-dong, Dongdaemun-Gu, Seoul, Korea. Tel: +82-2-2173-8812, Fax: + 82-2-959-4645, email: leechangjun@hufs.ac.kr.

Abstract

We propose a simple way to capture the multidimensionality of liquidity. Our analysis indicates that existing liquidity measures have considerable asset specific components, which justifies our new approach. Constructing a two-factor model with the market and liquidity factor proposed in this paper, we find that our two-factor model explains well the cross-section of stock returns in Korea from 1987 to 2010, describing the liquidity premium, size and value effects that the CAPM and Fama-French three-factor model fail to explain. Our results also show that the role of liquidity risk on expected stock returns is especially pronounced during the post-Asian financial crisis period.

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