The investment universe consists of Chinese stocks with common shares from the WIND database, listed in the Shanghai Stock Exchange and the Shenzhen Stock Exchange.
ASSET CLASS: stocks | REGION: China | FREQUENCY:
Monthly | MARKET: equities | KEYWORD: Illiquidity Factor, China
I. STRATEGY IN A NUTSHELL
Universe: Chinese A-shares from WIND (Shanghai + Shenzhen Stock Exchanges).
Signal: Inverse turnover (INVTO) = 1 ÷ turnover ratio.
Turnover ratio = traded shares ÷ total shares (per month).
Portfolio construction:
Value-weighted, rebalanced monthly.
Sort all stocks each month into 5 quintiles by INVTO.
Long quintile 5 (highest INVTO = lowest turnover = least traded = more illiquid).
Short quintile 1 (lowest INVTO = highest turnover = most liquid).
II. ECONOMIC RATIONALE
Liquidity is central in China:
Trading mechanism: Call + continuous auction; low counterparties = higher liquidity risk.
Investor base: Retail dominance (≈99.7% of accounts) → speculative, short-term, high turnover.
Short selling restrictions: Limited (<1% of trading volume), gradually rising but still low → increases market friction.
Higher cost of capital: China’s equity cost is higher than the US (Carpenter et al., 2021), making liquidity factors especially powerful predictors.
Implication: Illiquidity premium exists → stocks with lower turnover (higher INVTO) deliver higher returns because investors demand compensation for bearing liquidity risk.
III. SOURCE PAPER
How Is Illiquidity Priced in the Chinese Stock Market? [Click to Open PDF]
Jun Liu, Tilburg University – TIAS School for Business and Society; Kai Wu, Central University of Finance and Economics (CUFE) – School of Finance; Fuwei Jiang, Central University of Finance and Economics (CUFE); Zhiqi Shen, Guosheng Securities
<Abstract>
Using 3,589 stocks in China, we find that the liquidity premium ranges from 3.3% to 8.0% per month, and it remains to persist after controlling other well-known firm characteristics. The liquidity-based strategy explains China’s cross-section and time-series expected returns regardless of which measure is employed. It suggests that investors in China are faced with high transaction costs and systematic risk. Our multivariate decomposition approach highlights that characteristic momentum and idiosyncratic volatility account for more than 60% of the illiquidity premium.
IV. BACKTEST PERFORMANCE
| Annualised Return | 115.32% |
| Volatility | 33.93% |
| Beta | N/A |
| Sharpe Ratio | 3.39 |
| Sortino Ratio | N/A |
| Maximum Drawdown | N/A |
| Win Rate | N/A |
