This study investigates the impact of liquidity risk on stock returns of 149 firms in the industrial products and services sectors of Bursa Malaysia from January 2000 to December 2018 with a monthly frequency dataset. This study employed the two-stage standard procedures in asset pricing to estimate the significant effect of liquidity risk on industrial products and services stock returns. The results show that the investors require liquidity premium for stocks whose illiquidity co-moves with market illiquidity and market return while shifting their investment to liquid stocks when the market becomes illiquid, thus positive premium for stocks whose return is higher during the illiquid market. It suggests that two liquidity risks, namely commonality in liquidity and the covariances between stock illiquidity and market returns, and aggregate liquidity risk explain the cross-sectional returns variations across stocks in the industrial products and services sector, thus partly support the LCAPM model. We provide evidence on the important role of liquidity risks on the cross-sectional industrial products and services stock returns in Bursa Malaysia in the LCAPM framework. The findings of this study may be useful for investment decision-making and portfolio allocation strategy under the liquid and illiquid securities conditions. For policymakers, understanding the impact of liquidity risks on stock returns for the industrial products and services sectors may help enhance market liquidity for economic growth. Therefore, our findings contribute to the practical and policy implications.

This study investigates the impact of liquidity risk on stock returns in the Malaysian stock exchange using the LCAPM model of Acharya and Pedersen. This research employed firm-level equity data involving 419 continuously listed firms in Bursa Malaysia from January 2000 to December 2018. The study employed LCAPM asset pricing model tested using Fama-Macbeth two-stage cross-sectional regression. The findings suggest that the covariance between stock illiquidity and the market return is not priced in the Malaysian stock market. While, the other explanatory variables are significant in explaining the cross-sectional variations of stock returns, but only two variables; the commonality in liquidity and net liquidity risks are correctly signed. The evidence is limited to Malaysian corporations listed in the Main Market of Bursa Malaysia. These findings show some new evidence on the application of the LCAPM model in the emerging markets by using the closing per cent quoted spread impact (CPQS Impact) of Chung and Zhang (2014) as a measure of illiquidity. This research provides new insights on LCAPM application in the Malaysian stock market.