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Small Firm Effect, Liquidity and Security Returns

Australian Evidence

Michael E. Drew is at the School of Economics and Finance, Queensland University of Technology, GPO Box 2434, Brisbane, Queensland, 4001, Australia.

Alastair Marsden

Alastair Marsden is at the Department of Accounting and Finance, The University of Auckland Business School, Private Bag 92019, Auckland, New Zealand.

Madhu Veeraraghavan

Madhu Veeraraghavan (corresponding author) is at the Department of Accounting and Finance, Monash University, Clayton Victoria 3800, Australia. E-mail: Madhu.Veeraraghavan{at}BusEco.monash.edu.au

Standard asset pricing models ignore the costs of liquidity. In this study we advance the ongoing debate on empirical asset pricing and test if liquidity costs (as proxied by turnover rate, turnover ratio and bid-ask spread) affect stock returns for Australian stocks. Our tests use the factor portfolio mimicking approach of Fama and French (1993, 1996). We find small and less liquid firms generate positive risk premia after controlling for market returns and firm size. We find no evidence of any seasonal effects that can explain our multifactor asset pricing model findings. In summary, our study provides support for a broader asset pricing model with multiple risk factors.

Key Words: JEL Classification: G120 • JEL Classification: G150 • Liquidity • turnover • asset pricing • closing bid-ask spread

Journal of Emerging Market Finance, Vol. 5, No. 2, 135-149 (2006)
DOI: 10.1177/097265270600500202


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