Performances of liquidity factors in the stock market cycle: evidence from the Tokyo Stock Exchange

Purpose The purpose of this study is to examine the performances of liquidity factors in the stock market cycle. It aims to investigate whether the contribution of liquidity factors changes with stock market trends. Design/methodology/approach Six liquidity proxies and two-factor construction methods are compared in this study. The spanning regression method was applied to examine the contribution of liquidity factors to the asset pricing model, while the Fama and MacBeth regression method was used for examining the pricing power of liquidity factors. Findings The result shows that liquidity factors are accretive to models explaining returns in bull markets but not accretive to models in bear markets. The most appropriate method of constructing liquidity factors in the Japanese stock market has also been clarified. Originality/value In the Japanese stock market, there has never been a comprehensive test of the role of the liquidity risk factor in different market trends using the long-run data. This study helps with identifying the importance of liquidity pricing risk in different market trends. It also fills the gaps by comparing liquidity factors that are constructed through different methods and proxies and provides evidence for further confirming the correct asset pricing model in the future.