Illiquidity, Investor Sentiment and Stock Returns; Evidence from Malaysia

Market illiquidity (ILQ) and investor sentiment (IS) show a significant role in Malaysian capital market, the variation of average stock returns left unexplained by capital asset pricing model is covered effectively by ILQ and sentiment risks. Our IS measure consists of six market proxies. This study tests pricing implications using size, liquidity and BM ranked portfolios. It finds that small and illiquid stocks are exposed more to sentiment risk. ILQ and sentiment factors jointly explain the variations explained by size and value effects. Furthermore, quantile regressions reveal an asymmetric influence of IS, a large (small) effect is observed on stocks with high (low) returns. A three factor model directed at capturing ILQ and IS risks is apparently persuasive in this market.