1. The Liquidity-Augmented CAPM: Empirical Evidence from the JSE Christo Auret and David McClelland

2. Presentation Outline o Background and Literature o Motivation o Augmenting Liquidity and CAPM: Lius Two-Factor Model o Preliminary Analysis and Results o Still to be Investigated

3. Background Empirical failings of the CAPM Attempts to address these failings: Empirical approachTheoretical approach Address the empiricalAddress the limitations of limitation by CAPMs simplifying including variables thatassumptions directly capture documented anomalies

4. Background The assumption of frictionless capital markets has particularly severe implications for cross-sectional homogeneity with respect to trading costs, volumes, speeds and depth The degree to which assets or a market resemble this frictionless state can be seen as their level of liquidity The ability to trade large quantities quickly at low cost with small price impact Furthermore, illiquidity seems to severely affects market Beta estimation

5. Literature Review Trading Cost (Bid-Ask Spreads) Amihud and Mendelson (1986) Trading Quantity (Turnover) Datar et al. (1998) Price Impact of Trading Amihud (2002) Pastor and Stambaugh (2003) Trading Speed Liu (2006)

6. Motivation Gap in the current South African literature for tests of asset pricing models that include a comprehensive liquidity factor Test the international robustness of Lius 2-factor model Possibly provide a comprehensive asset pricing solution that can be used for the smaller less liquid stocks that are abundant on the JSE

7. Augmenting Liquidity and CAPM: Liu (2006) Two-Factor Model The liquidity measure (LM 12 ) is constructed as follows: LM 12 = [number of zero daily volumes in prior 12 months + ] x Where NoTD is the total number of trading days over the past 12 months and the Deflator is chosen such that : Benefit of this measure: Shown to be highly significant internationally Required data is easily available

8. Preliminary Analysis

10. Preliminary Results Liquidity sort into deciles

11. Preliminary Results Size sort into deciles

12. Preliminary Results B/M sort into deciles

13. Preliminary Results Dual sort into 9 portfolios

14. Preliminary Results Dual sort into 9 portfolios

15. Still to be Investigated Analyse Lius 2-Factor model compared to FF 3 Factor model and the CAPM in explaining excess returns as sorted according to value and size criteria Compare the mimicking liquidity factor to an innovations based liquidity risk Compare and contrast results of different holding period returns Expand sample backwards, pre-1997, and forward to the end of 2011

16. Questions? Thank you!