Expanding the Understanding of Socioeconomic Challenges in Developing Countries: Evidence on the Link between Market Liquidity and Stock Returns

Research in advanced markets has identified a negative and significant relationship between stock returns and liquidity. Conversely, research on emerging markets yields conflicting findings, indicating either a positive relationship or no relationship between liquidity and stock returns. This raises questions over liquidity constraints potentially stemming from socioeconomic factors in emerging stock markets, where institutional frameworks and socioeconomic challenges may affect market dynamics. This paper studies the impact of liquidity levels on stock returns in one of the major emerging stock markets in Asia. Data at the firm level were obtained from equities listed on Bursa Malaysia. Turnover ratios were employed to assess liquidity levels, as well as other known variables associated with stock returns, including size, book-to-market equity, and momentum. This study examines several hypotheses concerning the relationship between stock returns, liquidity, and other control variables through panel data regression analyses. The findings indicate that stock returns were not explained by beta during the period of study. Stock returns appeared to be positively influenced by size and turnover ratio, but negatively affected by momentum, book-to-market ratio, and variability in liquidity. Further investigations reveal that the results were mostly robust and demonstrated a non-linear relationship between liquidity levels and stock returns, with higher liquidity exerting a much higher influence on returns. The robustness of the results was assessed in relation to the January effect, non-linearity of liquidity, and variability of liquidity – elements that may be especially pertinent in emerging markets. The study's findings suggest that the conflicting results may be attributable to the additional socioeconomic challenges present in emerging markets, which may have impacted the outcomes.