Liquidity measurements and the return-liquidity relationship: empirical evidence from Germany, the UK, the US and China

This thesis was submitted for the award of Doctor of Philosophy and was awarded by Brunel University LondonWith reference to the existing literature on liquidity, three key questions have emerged during the last several decades: (i) How to measure liquidity in the most efficient way? (ii) What is the empirical pattern in the relation between market liquidity and stock returns? (iii) What are the determinants of the changes in the Return-Liquidity Relationship? This thesis take the above three questions as its principal focus and studies them by undertaking three separate empirical chapters, using a substantial dataset that covers all the listed firms in these four global economies – Germany, the UK, the US and China from 2001 to 2013. The empirical results imply the following: (i) The Transaction-Cost based liquidity measures, particularly the Quoted Proportional Spread, should be regarded as the most representative liquidity measurement. (ii) There is no evidence consistent with a fixed empirical pattern in the Return-Liquidity Relationship across these four countries as market liquidity is preferred in both Germany and UK, while the opposite results have been obtained for the Chinese stock market. That is, higher market leads to higher stock returns in these two European countries as the higher market liquidity facilitates capital movements to more efficient investments. However in China, the huge number of individual investors generates higher market liquidity through speculative trading rather than as a result of value-related investments, which heightens market risk and thus results in a decrease in stock prices. (iii) There is weak evidence that stock market returns have positive determinant effects on both MLIs (the market impact of liquidity on stock returns) and FLIs, (the firm-level impact of liquidity on stock returns) Return-Liquidity relation on market and firm level respectively. While only FLIs are positively correlated with stock market volatility and the inflation rate and negatively affected by the short-term interest rate