NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Liquidity and Expected Returns: Lessons From Emerging Markets

Geert Bekaert, Campbell R. Harvey, Christian Lundblad

NBER Working Paper No. 11413
Issued in June 2005
NBER Program(s):   AP

Given the cross-sectional and temporal variation in their liquidity, emerging equity markets provide an ideal setting to examine the impact of liquidity on expected returns. Our main liquidity measure is a transformation of the proportion of zero daily firm returns, averaged over the month. We find that our liquidity measures significantly predict future returns, whereas alternative measures such as turnover do not. Consistent with liquidity being a priced factor, unexpected liquidity shocks are positively correlated with contemporaneous return shocks and negatively correlated with shocks to the dividend yield. We consider a simple asset pricing model with liquidity and the market portfolio as risk factors and transaction costs that are proportional to liquidity. The model differentiates between integrated and segmented countries and periods. Our results suggest that local market liquidity is an important driver of expected returns in emerging markets, and that the liberalization process has not eliminated its impact.

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Document Object Identifier (DOI): 10.3386/w11413

Published: Geert Bekaert & Campbell R. Harvey & Christian Lundblad, 2007. "Liquidity and Expected Returns: Lessons from Emerging Markets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 20(6), pages 1783-1831, November. citation courtesy of

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