A STUDY OF THE RELATIONSHIP BETWEEN BID-ASK SPREAD AND RETURN OF SINGAPORE COMMON STOCKS

Abstract

The paper attempts to establish a possible relationship between liquidity and asset pricing. Literature on asset pricing recognises that an illiquid asset of equivalent risk can contain a return premium compared to another liquid asset to compensate investors for the higher cost of transacting. Using a sample of corporate securities traded on the Stock Exchange of Singapore in the period between 1983 and 1985, the paper proceeds to test this relationship. The bid-ask spread of the stock is used as an inverse measure of liquidity. The results obtained are statistically insignificant though similar studies on stock markets abroad indicate otherwise. That is, there is no conclusive evidence to suggest that investors in the local stock market are being adequately compensated for a higher transacting cost as indicated by a higher bid-ask spread. This anomaly could be due to the peculiarity of the stock market during the period of study.