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International Review of Business Research Papers Vol. 8. No.1. January 2012. Pp. 20 - 32

Pricing of Liquidity Risk in Emerging Markets: Evidence from Greater China
Kuntonrat Davivongs1 and Pantisa Pavabutr2
This paper used the liquidity adjusted capital asset pricing model of Acharya and Pedersen (2005) to examine the liquidity risk of stocks in two retail-based equity markets, China and Taiwan during the period of 1996-2008. We found that the proportion of liquidity risk overwhelms market risk, unlike the findings in US markets. As a pricing factor, the evidence indicated that systematic liquidity risk was more important than market risk in Taiwan. In China, crosssectional differences in individual firm liquidity explained differences in returns.

JEL codes: G12, G15 Key Words: Asset Pricing, Liquidity Risk, Emerging Markets

1. Introduction
The diversity of liquidity features and their importance in asset pricing have been an active area of research. The main conclusions drawn from existing works are that there exists commonality in liquidity (Chordia et al., 2000, Huberman and Halka, 2001, Hasbrouck and Seppi, 2001) and that investors demand premium from illiquidity (Amihud and Mendelson, 1986, Brennan and Subrahmanyam, 1996, Datar et al., 1998, Amihud, 2002). What is less understood is the relative importance of market risk to liquidity risk. In an attempt to shed light on this issue, Acharya and Pedersen (2005) used an equilibrium model as a framework to measure possible channels of liquidity risk. Although the authors found their ―Liquidity Adjusted Asset Pricing Model‖ provided a better fit than the standard capital asset pricing model, they found only weak evidence that liquidity risk was more important than market risk in U.S. data. The result of U.S. stock market study may not be applied to emerging markets since these two markets differ in many

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