ABSRJ 2020 Volume 11, Number 1

Pricing of liquidity risk in the Indian stock market

Namitha K Cheriyan
CHRIST, India
namicheriyan@gmail.com

Daniel Lazar
Pondicherry University, India
lazar.dani@gmail.com

Abstract

Empirical literature from developed stock markets identifies liquidity risk to have impacts on the price of a stock. Given this, using one-minute trade and quote data of fifty stocks constituting the NIFTY 50 Index, this study examines the pricing of liquidity risk in the Indian stock market. The study uses thirteen liquidity measures identified from literature that cover the cost, quantity, time and multidimensional aspects of liquidity. The innovations in the liquidity measures are considered as the proxy for liquidity risk. Employing Generalized Methods of Moments estimation, the study proves that Indian investors expect to have a premium for holding securities that are illiquid when the whole market is illiquid. It proves liquidity risk as a priced factor and thus validates the liquidity-adjusted capital asset pricing model in the Indian stock market. It cautions the investors that the liquidity shocks can have significant inferences on portfolio diversification strategies to be adopted.

Keywords: liquidity; liquidity risk; liquidity innovations; capital asset pricing model; liquidity beta; GMM

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