UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM – NETHERLANDS PROGRAM FOR MA IN DEVELOPMENT ECONOMICS LIQUIDITY PREMIUM IN STOCK RETURNS, THE CASE OF VIETNAM A thesis submitted in partial fulfilment of the requirement for the degree of MASTER OF ART IN DEVELOPMENT ECONOMICS By TRẦN QUANG DUY Academic supervision Dr. PHẠM PHÚ QUỐC HO CHI MINH CITY, December 2015 TIEU LUAN MOI download : skknchat@gmail.com DECLARATION It is to certify that this thesis entitled “Liquidity premium in stock returns, the case of Vietnam” meet all requirements for the Master Degree of Art in Development Economics. This thesis and all contents presented in it are developed by me as my own original research. It is neither in part nor in whole been presented for another degree elsewhere.
Trần Quang Duy ……………………………. ……………………………… (Author’s name) (Signature) (Date) LIQUIDITY PREMIUM IN STOCK RETURNS, THE CASE OF VIETNAM Page | i TIEU LUAN MOI download : skknchat@gmail.com ACKNOWLEDGEMENT Firstly, I would like to express my profound appreciation to my supervisor, Dr. Phạm Phú Quốc. He has kindly guided and shared with me his experience as well as knowledge about conducting a research.
He always reminded me and assist me in selecting the right path for my thesis. I also would like to say thank to Dr. Võ Hồng Đức, who initially shared with me the idea about research in stock returns My special thanks to Nguyễn Duy Tân and Võ Thế Anh, who dedicated their time and effort in helping me attain the huge data set for this thesis as well as overcame number of obstacles during my thesis. I would like to express my sincere gratitude toward all lectures and staffs in Vietnam Netherlands program for their kindness and dedication in teaching and providing the best study environment.
Furthermore, I would like to say thank to all my friends in the course of my study at this program. We have studied and been through many subjects, assignments together. They always beside and remind me whenever I feel discouragement so that I can finally finish this thesis. Last but not least, I am indebted to my parents who gave me all the love and support for every steps of my life.
Their contribution is enormous and I can never pay back this. LIQUIDITY PREMIUM IN STOCK RETURNS, THE CASE OF VIETNAM Page | ii TIEU LUAN MOI download : skknchat@gmail.com ABSTRACT Research about the role of liquidity in explaining stock returns has mainly been conducted in developed market and yielded ambiguous conclusion about its explanatory power. From this gap in literature, this empirical research is conducted to examine the influence of liquidity on stock returns in Vietnam stock market, a frontier market. From literature of liquidity and stock returns, there are number of available proxies for liquidity.
In this research, Turnover and Amihud illiquidity ratio are selected as two main liquidity proxies. These two proxies were selected because they showed a great consistency and reliability among available liquidity proxies for empirical research. This study also includes some common explanatory variables in stock return literature as control variables in empirical regressions. These variables are five premium factors of Fama and French as well as cumulative returns factor.
All of these factors are constructed by using portfolio formation method of Fama and French. The sample for this research includes all non- financial firms in Ho Chi Minh stock exchange (HOSE) for period 2007 to 2013. The regression method is Fama MacBeth which is often employed in finding stock returns. This research reveals some noticeable findings.
Firstly, liquidity negatively related to stock returns. This finding was reliable as two liquidity proxies point to the same conclusion. Secondly, all Fama and French factors showed that they are very effective in explain stock returns as all these variables present very convincing results. Thirdly, the empirical result from this study fail to support the role cumulative return factor in explaining stock returns in Vietnam.
Key words: Fama and French factors, turnover measure, Amihud illiquidity ratio, stock returns, Fama McBeth regression, listed companies, SMB, HML, CMA, RMW. LIQUIDITY PREMIUM IN STOCK RETURNS, THE CASE OF VIETNAM Page | iii TIEU LUAN MOI download : skknchat@gmail.com TABLE OF CONTENTS CHAPTER 1: INTRODUCTION .6 THE STRUCTURE OF THIS THESIS:. 5 CHAPTER 2: LITERATURE REVIEW .1 The Efficient Market Hypothesis: .2 Modern Portfolio Theory: .3 The Capital Asset Pricing Model: .2 ASSET RETURNS LITERATURE:.1 Theoretical vs Data Mining Research: .2 Fama – French Three Factors Model: .3 Carhart Four Factors Model: .4 Fama – French Five Factors Model: .1 Transaction Cost Theory: .2 Subsequent Development in Liquidity research:. 27 CHAPTER 3: DATA AND METHODOLOGY .1 REGRESSION MODEL AND RESEARCH FRAMEWORK:.
32 LIQUIDITY PREMIUM IN STOCK RETURNS, THE CASE OF VIETNAM Page | iv TIEU LUAN MOI download : skknchat@gmail.1 Primary Data Calculation:.6 SOLVING POTENTIAL ECONOMETRIC ISSUES: .1 Dealing with Heteroscedasticity and Autocorrelation: .2 Dealing with Multicollinearity:. 47 CHAPTER 4: DATA ANALYSIS AND RESULTS .2 Amihud Illiquidity Ratio: .1 Empirical Results for Turnover Measure:.2 Empirical Results for Amihud’s Illiquidity Measure: .5 LIMITATIONS AND FUTURE RESEARCH SUGGESTION:. 67 APPENDIX 1: TWO STAGE FAMA MACBETH REGRESSION. 67 LIQUIDITY PREMIUM IN STOCK RETURNS, THE CASE OF VIETNAM Page | v TIEU LUAN MOI download : skknchat@gmail.com LIST OF ABBREVIATIONS HOSE : Ho Chi Minh City Stock Exchange NYSE : New York Stock Exchange EMH : Efficient Market Hypothesis MPT : Modern Portfolio Theory CAPM : Capital Asset Pricing Model SMB : Small minus Big HML : High minus Low CMA : Conservative minus Aggressive RMW : Robust minus Weak FF : Fama and French LIQUIDITY PREMIUM IN STOCK RETURNS, THE CASE OF VIETNAM Page | vi TIEU LUAN MOI download : skknchat@gmail.com CHAPTER 1: INTRODUCTION 1.1 PROBLEM STATEMENT: This problem statement will firstly discuss about the essential role of stock market in each country as the stock market provides multiple benefits for investors, corporations and country‘s economy.
Drawing from these benefits, the second paragraph will mention about the establishment of stock market in most countries around the world. With the establishment of stock market and involvement of many social parties, stock returns become a special interest for many participants, especially for participants who directly engaged in the market. From this realistic need of many social parties about stock returns, the third, fourth and fifth paragraphs are dedicated for discussion about the quest of researchers in studying determinants of stock returns and the emergence of liquidity as one determinant of stock returns. The rest of this problem statement will demonstrate that current trend of liquidity research was excessively concentrated on developed market and there is an obvious need to have a thorough research about the influence of liquidity on stock returns in a frontier market, such as Vietnam.
Stock market is undeniably an integral part of each country economy. Stock market provide number of benefits for individual investors, corporations and economy. For corporation, stock market allow company to gain access to huge capital market. Once the company is listed, it can expand its capital through share issuance.
In addition, merge and acquisition can be facilitated by share purchase in the stock market. For investors, stock market provide investors a channel for investing their money. There are many different types of companies which should suit the taste of different investors. About economy, the key benefit of stock market is that it promotes economic growth by encouraging investors to put their saving into listed companies.
As a result, it encourages the companies’ development and promotes economic growth. With all of these advantages, stock market has been developed in many countries. Developed countries have their stock markets established for over centuries ago. With the establishment of stock market and involvement of many social parties, the stock returns become a special interest for many participants, especially for participants who directly involved in the market.
Specifically, for investors, stock returns is a major factor in deciding where their fund will be invested. For corporations, stock return should be a reliable gauge of companies’ performance as investors purchase and sell companies’ stock based on its fundamental and prospect. For economy and government, stock return is a dependable barometer for gauging the economic LIQUIDITY PREMIUM IN STOCK RETURNS, THE CASE OF VIETNAM Page | 1 TIEU LUAN MOI download : skknchat@gmail.com condition of a country. The stock price reflects the macroeconomic condition and major changes in country economy.
The rise and fall of stock price often coincides with economic cycle of a country (Pujari, 2010). As a result, government can observes the health of their stock market and promulgates suitable policies to regulate and develop their own economy. From this realistic need, many researchers have been devoting their efforts in studying about determinants of stock returns and its mechanism. The literature on stock returns nowadays is incredibly enormous and many scholars still keep searching for unknown determinants and new methodologies.
In reality, one factor that attracted attention of stock market participants and it has been noticed for a long time, this is liquidity. Liquidity is commonly defined as the ability to purchase or sell a large quantity of stocks quickly at low cost without affecting the price significantly (Choe & Yang, 2008). Through many years, investors observed that liquid stock can be easily converted into cash without much difficulties. In contrast, illiquid stock caused some level of difficulties for investors when they want to convert the stocks into cash.
It often requires investors to sell at a lower price or endure a greater transaction cost for the sale. With this in mind, investors well aware of the liquidity premium (the price spread between liquid and illiquid stocks). However, there wasn’t any remarkable study about liquidity until the well-known paper of Amihud and Mendelson (1986). Amihud and Mendelson (1986) were the pioneers in liquidity research when they proposed the transaction cost theory.
In their landmark paper, they found out evidence that there is a significant liquidity premium in asset return. Since the publication of this paper, many scholars started to develop this new field of literature. Many new proxies for liquidity have been formulated due to the need for measuring liquidity in different stock market. After years of liquidity research, some scholars agreed on the view that investors often require a higher rate of stock returns in compensating for illiquidity (Amihud, 2002), (Brennan & Subrahmanyam, 1996), (Brennan, Chordia, & Subrahmanyam, 1998), (Chordia, Roll, & Subrahmanyam, 2000).
This basically means liquidity affects negatively on stock returns. Nonetheless, there is divergence from the above viewpoint when other researchers found an opposite relationship. They claimed that the relationship is actually positive. To support this viewpoint, they also had their arguments and empirical researches (Bali, Peng, Shen, & Tang, 2014), (Abzari, Fathi, & Kabiripour, 2013).
An important fact is that the majority of researches about liquidity has been conducted in developed financial market, especially in United States (where most of data are available and it is LIQUIDITY PREMIUM IN STOCK RETURNS, THE CASE OF VIETNAM Page | 2 TIEU LUAN MOI download : skknchat@gmail.com one of the most developed financial market in the world). However, Bekaert, Harvey, and Lundblad (2007) stated that the liquidity effect should be stronger in emerging market than in developed one. They stated some rationales for their conclusion. The first reason is that poor liquidity was the main factor that prevented foreign institutional investors from invest their money into different types of stock in emerging market.
As a result, this would intensify the liquidity premium (frontier market even suffers a greater liquidity gap than emerging market). Secondly, many emerging market went through market liberalization during their research period. And this incident should assist researchers in study the importance of liquidity on expected return. The reason is that, after liberalization, the liquidity often increases noticeably in comparison with prior liberalization period.
Thirdly, developed markets often have diversified ownership structure with both long term and short term investors. Thus, Bekaert et al.