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Zhang, Qingjing, Choudhry, Taufiq, Kuo, Jing-Ming and Liu, Xiaoquan (2021) Does liquidity drive stock market returns? the role of investor risk aversion. Review of Quantitative Finance and Accounting . ISSN 0924-865X

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Abstract

In this paper, we explore the relations between liquidity, stock returns, and investor risk aversion as captured by the variance risk premium (VRP). This is motivated by theoretical and empirical evidence in the literature which suggests that investor risk aversion negatively correlates with asset liquidity, and ample empirical evidence documenting liquidity risk premium. We use monthly US data from January 1999 to December 2018 and show that innovations in the VRP Granger-cause stock returns, which in turn drive liquidity. Our findings are consistent with predictions of prior theories and highlight the predictability of the VRP. They also contribute to the on-going debate on the causal relation between stock returns and liquidity. Finally, we explore the channels through which the VRP impacts liquidity and find that the VRP influences market and momentum factors, and that movements in these factors lead to changes in liquidity. © 2021, The Author(s), under exclusive licence to Springer Science+Business Media, LLC, part of Springer Nature.

Item Type:	Article
Keywords:	Investor risk aversion; Liquidity; Systematic factors; Toda-Yamamoto Granger non-causality test
Schools/Departments:	University of Nottingham Ningbo China > Faculty of Business > Nottingham University Business School China
Identification Number:	10.1007/s11156-021-00966-5
Depositing User:	QIU, Lulu
Date Deposited:	04 Jun 2021 07:09
Last Modified:	04 Jun 2021 07:09
URI:	https://eprints.nottingham.ac.uk/id/eprint/65412

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