Test of the relationship between liquidity and stock returns in HCM stock exchange (hose)

Abstract

The thesis’s objective is to investigate the relationship between stock returns and liquidity using the data on Ho Chi Minh Stock Exchange over the period 2005-2009. This thesis follows the methodology of Drew et al.’s study (2004) that adopts the factor mimicking portfolio approach of Fama-French (1993, 1996) to test the presence of any liquidity premium. The trading volume and ILLIQ are employed as liquidity proxy in my thesis. The importance of liquidity in pricing stocks is examined with the controlled variables of market risk factor and firm size. This thesis concludes that the liquidity also plays a significant role in explaining the variation of stock returns in Vietnam stock market besides two familiar factors of market and firm size. The testing results for two representatives of liquidity suggest that the stock returns are negatively related to trading volume and positively related to ILLIQ. If the existence of financial crisis is taken into consideration, the negative relationship between stock returns and trading volume is just consistent in the pre-crisis period meanwhile the above positive relationship between stock returns and ILLIQ is consistent in both the pre-crisis period and the period that economic crisis started to affect Vietnam. Therefore, the empirical results indicate that, depending on the characteristics of each stage of economy, the investors should include the liquidity factor into the asset pricing models to minimize the bad performances.