The study of liquidity and asset pricing: evidence from Thailand stock market.

Abstract

This paper examines the role of liquidity in stock returns in a Thai stock market. Using the five-factors include the market factor (market risk premium, MKT), the size factor (small market capitalization minus big market capitalization, SMB), the book-to-market factor (high book-to-market equity ratio minus low book-to-market equity ratio, HML), the momentum factor (winners minus losers, WML) and liquidity factor (LIQ). Our data cover stocks traded in the Stock Exchange of Thailand (SET100) from April 2002 to March 2013. Monthly excess stock returns are computed from nine testing portfolios based on size and book-to-market ratios. Time series regressions following Fama and French (1992)are employed to test the five-factor model on these nine testing portfolios. The test result shows that the Gibbons-Ross-Shanken (GRS) statistic reject the null hypothesis of zero alphas (risk-adjusted excess return) in every model. After adding a liquidity factor to the model, the number of significant intercepts is reduced and the average adjusted R2 increase. These results showed that the Five-factor model have more explanatory power than the traditional CAPM model. However, the regression results suggested that momentum factor and Amihud’s liquidity factor might not be an important factor in asset pricing models. The results also showed that adding momentum factor and liquidity factor to the Fama-French model barely increased the explanatory power. In conclusion, Fama-French model alone can explain the stock return of Thai stock market. KEY WORDS: Fama-French’s three factor model / Carhart’s four factor model / Amihud’s liquidity/ Asset pricing / Thai stock return