This thesis aims to explore stock liquidity, a crucial attribute of financial assets, in USmarket. In particular, this research attempts to address a number of issues in the theoreticalstudy of liquidity, some of which even still matters for debate.The empirical results in Chapter 3 suggest that the significance of liquidity on asset returnsis time specific, in other words, the heterogeneity between liquidity components exhibits aBusiness Cycle effect. In particular, the liquidity risk premium is strengthened duringdownturns of the market conditions, as the association between the asset liquidity andreturn in the cross-sectional dimension is relatively stronger in the period of lower marketliquidity. Besides, the analysis is carried out that focuses on the interrelationship betweenthe market-wide liquidity components and the market dynamics, and some interestingGranger causality relationship is detected. Specifically, price impact components areGranger caused by transaction costs and trading activity, but do not Granger cause tradingactivity. Moreover, the Granger causality detected in this section also explains that marketpast performance is caused by liquidity, especially the dimensions of trading activity andprice impact, and subsequently, the market-wide trading activity affects the marketportfolio most recent and further performance. These findings for liquidity measures in thiscomparative analysis establish a significant step towards the understanding of liquiditymeasures in a more systematic and consistent setting, and can be a good starting point forconstructing more robust liquidity measures.Based on a negative relationship between volatility of liquidity and asset returns, Chapter 4extends this finding and provides a comparative analysis of the volatility of liquidity risk through an asset pricing framework considering several dimensions of liquidity, such astransaction cost, trading activity and price impact. The empirical findings, consistent withthe literature, provide evidence of heterogeneity across various liquidity components andvolatility specifications. In addition, by extracting the commonality of volatility of liquidityacross individual assets via principal component analysis, the systematic components ofvolatility of liquidity are examined accordingly. Finally, a mimicking portfolio isconstructed and used to track the systematic risk of volatility of liquidity, providingevidences that the latter is priced in asset returns.Chapter 5 studies the impact of market-wide liquidity volatility on momentum profit. It isexamined by investigating whether the volatility of market liquidity dominates the marketliquidity level in terms of affecting and predicting the momentum profit. Besides, it isdetermined that the impact is state-dependent; in particular, the impact of the fluctuation ofthe market liquidity on the momentum payoff is stronger when the market volatility or theilliquidity is higher. Finally, by a closer inspection of the momentum crash event in 2009,it is observed that the volatility of market liquidity increases sharply a couple of monthsbefore the crash, while stays stable during and after the crash.This thesis provides implications for investment perspective in terms of the tradingstrategies based on liquidity as well as momentum. For instance, the performance of theliquidity measurement is time-varying associated with market conditions. Moreover, thefluctuation of market liquidity, i.e., the volatility of liquidity, should also be considered forpricing issues. The empirical results suggest that the asset, of which the liquidity fluctuatesheavily, usually has lower returns; this indication applies to six popular liquidity measuresaccording to the empirical results. More importantly, investors could make profits byreversing the momentum trading strategy in momentum crash periods.
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