Liquidity risk and expected returns in China's stock market: A multidimensional liquidity approach

We propose a multidimensional liquidity measure constructed from 6 out of 17 individual lowfrequency liquidity proxies. The multidimensional liquidity risk factor yields significant positive premiums and offers distinguished explanatory power on the cross-sectional return variations in China's stock market. A six-factor liquidity (L-6F) model is the best-performing liquidityembedded model for the Chinese market. The L-6F model outperforms the Fama and French (2015) five-factor model at explaining a series of return anomalies such as volatility, momentum, reversal, and skewness. Interestingly, the liquidity risk premium enlarges when market uncertainty escalates and systematic liquidity tightens, consistent with the "flight-to-liquidity" effect. Lastly, the multidimensional liquidity measure effectively captures high-frequency liquidity information and remains robust with alternative regression settings and liquidity estimation methods. The proposed multidimensional liquidity measure can be applied in liquidity risk management and liquidity-based trading strategies, and the L-6F model can be utilized in estimating risk-adjusted returns in China's stock market.