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The Liquidity-Augmented CAPM: Empirical Evidence from the JSE

The Liquidity-Augmented CAPM: Empirical Evidence from the JSE. Christo Auret and David McClelland. Presentation Outline. Background and Literature Motivation Augmenting Liquidity and CAPM: Liu’s Two-Factor Model Preliminary Analysis and Results Still to be Investigated. Background.

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The Liquidity-Augmented CAPM: Empirical Evidence from the JSE

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  1. The Liquidity-Augmented CAPM: Empirical Evidence from the JSE ChristoAuret and David McClelland

  2. Presentation Outline • Background and Literature • Motivation • Augmenting Liquidity and CAPM: Liu’s Two-Factor Model • Preliminary Analysis and Results • Still to be Investigated

  3. Background • Empirical failings of the CAPM • Attempts to address these failings: Empirical approachTheoretical approach Address the empirical Address the limitations of limitation by CAPM’s simplifying including variables that assumptions directly capture documented anomalies

  4. Background • The assumption of frictionless capital markets has particularly severe implications for cross-sectional homogeneity with respect to trading costs, volumes, speeds and depth • The degree to which assets or a market resemble this frictionless state can be seen as their level of liquidity • “The ability to trade large quantities quickly at low cost with small price impact” • Furthermore, illiquidity seems to severely affects market Beta estimation

  5. Literature Review • Trading Cost (Bid-Ask Spreads) • Amihud and Mendelson (1986) • Trading Quantity (Turnover) • Datar et al. (1998) • Price Impact of Trading • Amihud (2002) • Pastor and Stambaugh (2003) • Trading Speed • Liu (2006)

  6. Motivation • Gap in the current South African literature for tests of asset pricing models that include a comprehensive liquidity factor • Test the international robustness of Liu’s 2-factor model • Possibly provide a comprehensive asset pricing solution that can be used for the smaller less liquid stocks that are abundant on the JSE

  7. Augmenting Liquidity and CAPM: Liu (2006) Two-Factor Model The liquidity measure (LM12) is constructed as follows: • LM12 = [number of zero daily volumes in prior 12 months + ] x • Where NoTD is the total number of trading days over the past 12 months and the Deflator is chosen such that: • Benefit of this measure: • Shown to be highly significant internationally • Required data is easily available

  8. Preliminary Analysis

  9. Preliminary Analysis

  10. Preliminary Results Liquidity sort into deciles

  11. Preliminary Results Size sort into deciles

  12. Preliminary Results B/M sort into deciles

  13. Preliminary Results Dual sort into 9 portfolios

  14. Preliminary Results • Dual sort into 9 portfolios

  15. Still to be Investigated • Analyse Liu’s 2-Factor model compared to FF 3 Factor model and the CAPM in explaining excess returns as sorted according to value and size criteria • Compare the mimicking liquidity factor to an innovations based liquidity risk • Compare and contrast results of different holding period returns • Expand sample backwards, pre-1997, and forward to the end of 2011

  16. Thank you! Questions?

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