Abstract:
Market liquidity is an important aspect in the well-functioning of the financial markets. It represent the degree to which an asset or securities can be traded without affecting the price of the securities and at the shortest time possible. It is a multidimensional concept which constitute market depth, market breath, market tightness, market resiliency and which requires different measures to capture liquidity. The general objective of the study was to establish the effect of market liquidity and three factor model on excess return in Nairobi Securities Exchange. Specifically the study was to establish the effect of Bid Ask spread, Trading Volume, Price impact, Market resiliency and the three factor model on Excess return in Nairobi Securities Exchange. The research adopted quantitative research design. The population was comprised of all the 64 companies in Nairobi Securities Exchange (NSE). The data was obtained from Nairobi Securities Exchange (NSE) and the Central Bank of Kenya (CBK) publication for 10 years between the years 2006 to 2015. The study found that the variables considered had significant effect on market returns. In particular the market premium variable was found to be significant across all the six portfolios considered. The Value premum High minus Low (HML) and size pemium, Small minus Big (SMB) were found to be significant in most of the portfolios apart from a few. All the other variables as used to measure liquidity were found to have mixed effects across the market. The study concluded that the three factor asset pricing variables are quite significant in pricing the security and the market liquidity factors are also important for pricing the securities. The study recommends that the policy makers should initiate policies aimed at increasing on market liquidity. These policies should strive to lower transaction cost, increase volume of trade and increase the number of companies trading in Nairobi Securities Exchange (NSE). The study suggest the future research can look at the Macroeconomic effects on excess returns
