Commonality in Liquidity and Stock Market Return, Cross-Section: Evidence from the Stock Exchange of Malaysia

A new stream of research shows that liquidity is more than just a characteristic of a single asset, but little previous work has been devoted to the common determinants of liquidity especially in the order-driven trading markets as well as the emerging markets. This study examines to what extent liquidity is determined by common underlying factors in an emerging market that has adopted an order-driven trading system. Using Malaysia as a case for the study, we select a broad sample of stocks from the Malaysian stock exchange to measure and analyze market-wide movements in liquidity using data from 1992 to 2008. This study also attempts to extend the literature in this stream by examining if there is commonality of liquidity between the cross-listed stocks in the Malaysian stock market. This study also examines the relationship between illiquidity and expected return in the Stock Exchange of Malaysia. The empirical results showed a significant positive relation between illiquidity and expected return. Strong evidence is found for market-wide commonality in liquidity, which prevails across several liquidity measurements as effective spread proxies, Amivest liquidity ratio, share turnover ratio, and Amihud’s illiquidity ratio. The market-wide commonality is shown to be stronger in the crisis period in 1998 and 1999 compared to the other years in the study, and the cross listed-wide commonality is found to be stronger than market-wide commonality in liquidity.