Behavioral Economics & Finance

Assignment 10 Test the effect of stock market liquidity on stock returns – First, download the liquidity factor data from Dr. Pastor’s data library at https://faculty.chicagobooth.edu/lubos-pastor/data (click on ‘Liquidity factor data’) – the third column is the non-tradable factor (henceforth, PS) and the fourth column is the tradable factor (henceforth, PStd). Next, download the value-weighted monthly returns of the 10 momentum portfolios and the Fama-French three factors (labeled ‘Fama/French 3 Factors’) from Dr. French’s data library for the period January 1973 to December 2023. Test if the returns of each momentum portfolio can be fully explained by the FamaFrench 3 factors (i.e. to check if the intercept is significantly different from zero) by running the following regression: 𝑟𝑖,𝑡 = 𝛽𝑖0 + 𝛽𝑖𝑀 𝑀𝐾𝑇𝑡 + 𝛽𝑖𝑆 𝑆𝑀𝐵𝑡 + 𝛽𝑖𝐻 𝐻𝑀𝐿𝑡 + 𝜀𝑖,𝑡 , where 𝑟𝑖,𝑡 is the excess return of the ith momentum portfolio in month t (subtract the risk-free rate from the return of the ith momentum portfolio), 𝑀𝐾𝑇𝑡 is the excess market return, 𝑆𝑀𝐵𝑡 is the size factor, and 𝐻𝑀𝐿𝑡 is the value factor. Add the liquidity factor to the model as follows: 𝑟𝑖,𝑡 = 𝛽𝑖0 + 𝛽𝑖𝐿 𝐿𝑡 + 𝛽𝑖𝑀 𝑀𝐾𝑇𝑡 + 𝛽𝑖𝑆 𝑆𝑀𝐵𝑡 + 𝛽𝑖𝐵𝑀 𝐻𝑀𝐿𝑡 + 𝜀𝑖,𝑡 , where Lt is PS or PStd. Does the augmented model improve the pricing of momentum returns? Which liquidity factor, PS or PStd, does a better job in helping explain momentum returns? Please create your own table(s) to summarize your empirical results and offer brief interpretation of the results. 1