Abstract:
This study aims to analyze the relationship between stock returns and liquidity risk
while taking into account the time-varying characteristics of 1
illiquidity on the
Colombo Stock Exchange from 2015-2019 and taking into account the effect of
liquidity level, using the Generalized Method of Movements (GMM) framework
model to assess the persistence of illiquidity stocks. The updated version of Amihud
Illiquidity (Amihud, 1986) is a contribution that represents illiquidity and research
across the time-series relationship between liquidity and return. The price of liquidity
risk and its effect on expected returns are tested empirically using the conditional
liquidity adjusted capital asset pricing model (LCAPM), where stock returns are
cross-sectionally dependent on market risk and three additional betas (𝛽
1
, 𝛽
2
, 𝛽
3
) that
capture different aspects of illiquidity and its risk. The results show some support for
the conditional capital asset pricing model (CAPM), but the results are not robust to
alternative requirements and estimation methods. The total effect of liquidity risk is
0.11%, and illiquidity is 2.5% per year. The total annualized illiquidity premium is
therefore found that 2.61% in the Colombo stock exchange.
