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Which Market Enhances Market Efficiency by Improving Liquidity? Evidence of Market Liquidity in Relation to Returns of Stocks

Which Market Enhances Market Efficiency by Improving Liquidity? Evidence of Market Liquidity in... Market efficiency can be enhanced by market liquidity if it promotes value creation, leading to increasing stock returns. A positive relation between liquidity and stock returns implies capital movement towards more efficient investment at a low cost for value creation. Existing studies are controversial for the relation being positive, negative, or inconclusive. With such inconsistency, this paper uses data from more than 3,200 company stocks from the UK, the United States, Germany, and China securities markets over a 10-year period to estimate the relation across these four markets, respectively. The framework of estimation is robust to outliers and macro shocks, while eliminating the issues of multicollinearity, autocorrelation, and endogeneity. The study finds some interesting results. We report strong evidence for Germany and the UK of a positive relationship between returns and liquidity. In contrast, China exhibits the opposite result, and the United States provides inconclusive evidence, possibly caused by significant diversification of value perception on liquidity. Our results imply that the German and the UK markets are more efficient than the emerging market of China because liquidity assists capital movement more efficiently. The policy implication of this research is that, for emerging stock markets, the costs of capital movement should be reduced in order to increase the efficiency of funding allocation. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Asian Economic Papers MIT Press

Which Market Enhances Market Efficiency by Improving Liquidity? Evidence of Market Liquidity in Relation to Returns of Stocks

Asian Economic Papers , Volume 22 (1): 29 – Apr 8, 2023

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Publisher
MIT Press
Copyright
© 2023 by the Asian Economic Panel and the Massachusetts Institute of Technology
ISSN
1535-3516
eISSN
1536-0083
DOI
10.1162/asep_a_00860
Publisher site
See Article on Publisher Site

Abstract

Market efficiency can be enhanced by market liquidity if it promotes value creation, leading to increasing stock returns. A positive relation between liquidity and stock returns implies capital movement towards more efficient investment at a low cost for value creation. Existing studies are controversial for the relation being positive, negative, or inconclusive. With such inconsistency, this paper uses data from more than 3,200 company stocks from the UK, the United States, Germany, and China securities markets over a 10-year period to estimate the relation across these four markets, respectively. The framework of estimation is robust to outliers and macro shocks, while eliminating the issues of multicollinearity, autocorrelation, and endogeneity. The study finds some interesting results. We report strong evidence for Germany and the UK of a positive relationship between returns and liquidity. In contrast, China exhibits the opposite result, and the United States provides inconclusive evidence, possibly caused by significant diversification of value perception on liquidity. Our results imply that the German and the UK markets are more efficient than the emerging market of China because liquidity assists capital movement more efficiently. The policy implication of this research is that, for emerging stock markets, the costs of capital movement should be reduced in order to increase the efficiency of funding allocation.

Journal

Asian Economic PapersMIT Press

Published: Apr 8, 2023

References