Quantitative Study on the Existence and Determinants of Liquidity Premium in the Stock Market

Abstract

Market liquidity is one of the key factors influencing asset pricing and investor behavior, while liquidity premium refers to the cost investors pay for obtaining liquidity in stock markets. This study uses historical data from China's A-share market and selects multiple liquidity measures—such as the Amihud illiquidity measure, bid-ask spread, and turnover ratio—to conduct an empirical investigation into the existence and determinants of liquidity premium in the Chinese stock market. First, we construct a liquidity factor and incorporate it into the Fama-French three-factor model to examine whether liquidity premium can exist independently of market risk, size effect, and value effect. Then, using panel regression and grouped tests, we analyze the determinants of liquidity premium from both macro-level perspectives (e.g., overall market volatility and macroeconomic cycles) and micro-level perspectives (e.g., firm size, ownership concentration, and information disclosure). The results show that there is a significant liquidity premium in the Chinese stock market, which exhibits strong time variation—particularly higher during periods of high market volatility or liquidity stress. Moreover, smaller firms and stocks with higher degrees of information asymmetry face greater liquidity premiums. Additionally, the study finds that investor heterogeneity and asymmetric transaction costs are among the contributing factors to liquidity premium. This research enriches the empirical understanding of liquidity premium theory in emerging markets such as China and provides practical guidance for investors in asset allocation and for regulators in improving market liquidity.