Is Illiquidity Priced in the Chinese Stock Market?

Although liquidity has received wide attention in asset pricing literature over the past decades, how stock liquidity is priced in emerging markets remains unclear. We find that liquidity plays an important role in explaining the cross-section and time-series variation in expected returns by incorporating multi-dimensional liquidity proxies in the spread, depth, and trading activity. The predictive power persists after controlling the several conventional pricing factors. We also find that the high illiquidity quintile generates higher monthly risk-adjusted returns than the low illiquidity quintile, ranging from 3.2% to 8.4% per month. The results are robust to alternative stock liquidity measures and sampling criteria. Our findings highlight the profitability of liquidity-based trading strategy in the Chinese stock market.