This study provides the insight about role of liquidity premium in explaining the stock returns and aims to investigate the relationship between stock returns and liquidity premium of non-financial firms listed on Pakistan Stock Exchange. The study sample consists of hundred non-financial companies based on market capitalization listed on PSX for the period of 2001 to 2017. In order to capture the impact of liquidity premium on equity returns, various financial variables following the methodology of Fama-French (1993) with extension of liquidity premium are being followed. In the study, portfolio’s rate of return is used as dependent variable and market premium, size premium and value premium and liquidity premium are used as independent variables. This study uses multivariate regression with two pass regression model proposed by Fama and Macbeth (1973). The results showed that CAPM is insignificant for all the stylized portfolios of firms listed on the PSX whereas size and value factor are statistically significant and negatively affecting the equity returns for large stocks but positively associated with equity returns for small stocks. Liquidity premium is found to be statistically significant with negative impact on returns of all the liquidity sorted portfolios and confirmed about the presence of anomaly on PSX, except big portfolios with low B/M ratio and low liquidity and insignificant for small size firms having high b/m ratio but low liquidity. Supervisor:- Dr. Arshad Hassan