Empirical tests of the float-adjusted return model Feng Zhang a , Yao Tian b , Tony S. Wirjanto c, * a Sauder School of Business, University of British Columbia, Vancouver, BC, Canada V6T 1Z2 b School of Business, University of Alberta, Edmonton, Alberta, Canada T6G 2R6 c School of Accounting and Finance and Department of Statistics and Actuarial Science, University of Waterloo, Waterloo, Ontario, Canada N2L 3G1 article info Article history: Received 6 June 2009 Accepted 1 September 2009 Available online 16 September 2009 JEL Classification: G12 Keywords: Chinese stock market Free float Liquidity Stock returns abstract This paper implements empirical tests of the recently proposed float-adjusted return model by using Chinese stock-market data. The results show that variation in free float can explain cross-sec- tional variation in asset returns by about 6.7% annually, after we con- trol for market risk, size, and book-to-market equity. In addition, we also find that size and book-to-market equity help explain cross-sec- tional variations in returns even after controlling for free float. Ó 2009 Published by Elsevier Inc. 1. Introduction This paper provides first empirical tests of a float-adjusted return model (FARM) recently proposed by Weill (2008). FARM explains the pricing of liquidity differences with the following linear equation R i  R L ¼  / / i R FW M  R L   ð1Þ where R i denotes the return of asset i, one of the many assets traded in the equilibrium, R L denotes the return of an appropriately defined ‘‘perfectly liquid” asset, / i denotes the free float of asset i, defined as the portion of the market capitalization available for sale,  / denotes the market average free float; and, lastly, R FW M is the float-weighted market return. In other words, 1544-6123/$ - see front matter Ó 2009 Published by Elsevier Inc. doi:10.1016/j.frl.2009.09.001 * Corresponding author. Fax: +1 519 725 0530. E-mail addresses: feng.zhang@sauder.ubc.ca (F. Zhang), yao.tian@ualberta.ca (Y. Tian), twirjant@uwaterloo.ca (T.S. Wirjanto). Finance Research Letters 6 (2009) 219–229 Contents lists available at ScienceDirect Finance Research Letters journal homepage: www.elsevier.com/locate/frl