Illiquidity and asset pricing in the Chinese stock market

Purpose – Since illiquidity risk is one of the most important pricing factors of assets, the aim of this paper is to evaluate the suitability of proxies of illiquidity prevalent in the asset pricing literature and their explanatory power in asset pricing tests. Design/methodology/approach – Using the available high‐frequency intra‐day data, the paper constructs some proxies of illiquidity as benchmarks and then evaluates proxies of illiquidity based on inter‐day data. Findings – The empirical results provide convincing evidence that turnover is the most suitable proxy of illiquidity in the Chinese stock market. It is not only hghly related to intra‐day data‐based proxies of illiquidity but also completely superior to other measures of illiquidity in asset pricing tests. Originality/value – First, the paper applies illiquidity measurements from microstructure theory and the available high‐frequency data, and examines the suitability of illiquidity proxies in asset pricing literature in the Chinese stock market. Rational basics are provided to test the applicability of illiquidity measures in the Chinese stock market. Second, the paper introduces illiquidity proxies into asset pricing models to extend their explanatory power. The paper's results may help researchers to select illiquidity proxies more cautiously.