Liquidity and Stock Returns : Evidence from the Chinese Stock Market *

We investigate the role of liquidity in explaining stock returns in China’s stock market. We construct a new liquidity measure by capturing four liquidity dimensions. Our results show that liquidity is an important factor in pricing returns in China, after taking other well-documented asset-pricing factors into consideration. We compare alternative factor models and find that the model including the factors of market, size, value, and liquidity outperforms the other factor models in explaining stock returns in China. Our results are validated in both time-series and cross-sectional tests. They are also robust to adding portfolio residuals, higher moments, monthly seasonality, and conditional-market tests.