Illiquidity Factor in China
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Is Illiquidity Priced in the Chinese Stock Market?
Jun Liu; Kai Wu; Lang Zheng
- NLTIAS School for Business and Society
- NLTilburg University
- ?Tilburg University - TIAS School for Business and Society
- Central University of Finance and Economics
- ?Central University of Finance and Economics (CUFE) - School of Finance
- ?Central University of Finance and Economics (CUFE)
Strategy in a nutshell
Universe: Chinese A-shares from WIND (Shanghai + Shenzhen Stock Exchanges).
Signal: Inverse turnover (INVTO) = 1 ÷ turnover ratio.
Turnover ratio = traded shares ÷ total shares (per month).
Portfolio construction:
Value-weighted, rebalanced monthly.
Sort all stocks each month into 5 quintiles by INVTO.
Long quintile 5 (highest INVTO = lowest turnover = least traded = more illiquid).
Short quintile 1 (lowest INVTO = highest turnover = most liquid).
Economic rationale
Liquidity is central in China:
Trading mechanism: Call + continuous auction; low counterparties = higher liquidity risk.
Investor base: Retail dominance (≈99.7% of accounts) → speculative, short-term, high turnover.
Short selling restrictions: Limited (<1% of trading volume), gradually rising but still low → increases market friction.
Higher cost of capital: China’s equity cost is higher than the US (Carpenter et al., 2021), making liquidity factors especially powerful predictors.
Implication: Illiquidity premium exists → stocks with lower turnover (higher INVTO) deliver higher returns because investors demand compensation for bearing liquidity risk.