Liquidity, momentum and price bubbles : evidence from the UK
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The asset pricing anomalies have existed in the UK stock market for a long time. This thesis aims to study different liquidity measures, liquidity commonality, systematic liquidity risk, different momentum trading strategies, asset pricing risks with momentum, investor behaviours with momentum and the causal link between financial crisis and asset pricing anomalies using various methods and tests. The first empirical chapter examines the performance of the standard Sharpe- Lintner CAPM, the Fama-French three factor model, and the four factor model of Carhart (1997) both with, and without, the first component of multiple illiquidity measures. The results show that no individual illiquidity proxy outperforms the others, and further that the illiquidity proxies have a systematic common illiquidity component. The results also reveal that the inclusion of the illiquidity factor in the capital asset pricing model plays a significant role in explaining the crosssectional variation in stock returns. The second empirical chapter analyses the relationship between momentum profits and stock market illiquidity. This study finds negative and significant relationship between aggregate market illiquidity and momentum profits. The model applied in this chapter captures significant bounce in varying beta coe cients changing over time. The analysis also indicates that the stocks associated with high liquidity performs better relative to illiquid stocks under systemic shocks. The final empirical chapter investigated momentum anomaly and the hypothesis that individual investors trade differently from institutional investors and significantly overreact to economic shocks, creating destabilising effect in the stock market. The results reveal that stock market ineffi ciency is driven and dominated by individual investors' anchoring and adjustment biases as well as institutional investors' cognitive biases. There are several implications for this work. The findings may be useful for both individual and institutional investors and regulators in similar markets beyond the UK, for example, the other European markets. In this study, we show that abnormal stock performance during liquidity crisis is, in part, predictable, and investors can construct portfolios of stocks that better withstand liquidity shocks. For individual investors, they can maximise their profits by holding momentum portfolios at a short horizon. For institutional investors, they might take advantage of professional expertise in making abnormal profits. Policy makers are expected to pay special attention to the differences in trading by financial institutions and individual investors.