Liquidity in Up and Down Markets for Asset Pricing: Evidence from the Taiwan Stock Market

Using a sample of stocks listed on the Taiwan Stock Exchange during 1991–2014, this study investigates the liquidity in up and down markets, which is important for understanding asset pricing. Firm‐level original Amihud, Journal of Financial Markets, 5, 2002, 31. illiquidity is decomposed into two half‐Amihud measures for up‐ and down‐market days. First, we show that the ability of the down‐market liquidity level to explain the cross‐section of returns subsumes the up‐market liquidity level. Second, only loadings on systematic down‐market liquidity factors are significantly priced. Third, a liquidity risk factor constructed by the down‐market component, rather than the up‐market component significantly explains the time‐series and cross‐sectional variation in returns sorted by firm size, suggesting that the liquidity risk factor associated with down‐market days performs better in capturing the flight‐to‐liquidity. Overall, the findings support the view that the liquidity in down markets plays a more important role in asset pricing than the liquidity in up markets.