Working Paper: CEPR ID: DP7410
Authors: Dimitri Vayanos; Jiang Wang
Abstract: We examine how liquidity and asset prices are affected by the following market imperfections: asymmetric information, participation costs, transaction costs, leverage constraints, non-competitive behavior and search. Our model has three periods: agents are identical in the first, become heterogeneous and trade in the second, and consume asset payoffs in the third. We examine how imperfections in the second period affect different measures of illiquidity, as well as asset prices in the first period. Besides nesting multiple imperfections in a single model, we derive new results on the effects of each imperfection. Our results imply, in particular, that imperfections do not always raise expected returns, and can influence common measures of illiquidity in opposite directions.
Keywords: Asset Prices; Liquidity; Market Imperfections
JEL Codes: D8; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| participation costs (D23) | increase in expected returns (G17) |
| transaction costs (D23) | increase in expected returns (G17) |
| transaction costs (D23) | decrease in willingness to hold risky assets (G19) |
| decrease in willingness to hold risky assets (G19) | decrease in prices (E31) |
| liquidity demanders' trades (E41) | influence price dynamics (E30) |
| illiquidity (G33) | expected returns (G17) |
| different imperfections causing illiquidity (D43) | opposing effects on expected returns (G40) |
| lambda (Y60) | valid proxy for illiquidity (G19) |
| price reversal (F31) | valid under specific market imperfections (D43) |