Some hypothesis on commonality in liquidity: new evidence from the Chinese stock market

In this paper, we examine four specific hypotheses relating to commonality in liquidity on the Chinese stock markets. These hypotheses are: (a) that market-wide liquidity determines liquidity of individual stocks; (b) that liquidity varies with firm size; (c) that sectoral-based liquidity affects individual stock liquidities differently; and (d) that commonality in liquidity has an asymmetric effect. Based on a two-year dataset on the Shanghai and Shenzhen stock exchanges comprising of over 34 and 48 million transactions respectively, we find strong support for commonality in liquidity and a greater influence of industry-wide liquidity in explaining liquidity of individual stocks. Moreover, our results suggest that of the three main sectors ? financial, industrial, and resources ? industrial sector‟s liquidity is most important in explaining individual stock liquidities. Finally, we do not find any evidence of size effects, and document an asymmetric effect of market-wide liquidity on liquidity of individual stocks.