Equilibrium Liquidity Premia PDF Download

Excerpt from Equilibrium Interest Rate and Liquidity Premium Under Proportional Transactions Costs In this paper we analyze the impact of transactions costs on the rates of return on liquid and illiquid assets. We consider an infinite horizon economy with finitely lived agents along the lines of Blanchard(1985). In this economy agents face a constant probability of death, and the population is kept constant by an inflow of new arrivals. Agents start with no financial wealth and receive a decreasing stream of labor income over their lifetimes. In addition they can invest in long term assets which pay a constant stream of dividends. There are two such assets, the liquid asset and the illiquid asset. The liquid asset is traded without transaction costs, while trading the illiquid asset entails proportional transactions costs. Neither asset can be sold short. Agents buy and sell assets for lifecycle motives. In fact, they accumulate the higher yielding illiquid asset for long term investment purposes and the liquid asset for short term investment needs. We find that when transactions costs increase, the rate of return on the liquid asset decreases, while the rate of return on the illiquid asset may increase or decrease. We also find, quite naturally, that the liquidity premium increases. The effects of transactions costs on the rate of return on the liquid asset and on the liquidity premium, are stronger the higher the fraction of the illiquid assets in the economy. Finally, transactions costs have first order effects on asset returns and on the liquidity premium. We evaluate these effects for reasonable parameter values. Acknowledgments: We would like to thank participants in the Nber Conference on Asset Pricing in Philadelphia; participants at seminars at Mtt, New York University and Wharton; Drew Fudenberg, Mark Gertler, John Heaton and Jean Tirole for helpful comments and suggestions. We also wish to acknowledge financial support from the International Financial Services Research Center at the Sloan School of Management. Errors are ours. About the Publisher Forgotten Books publishes hundreds of thousands of rare and classic books. Find more at www.forgottenbooks.com This book is a reproduction of an important historical work. Forgotten Books uses state-of-the-art technology to digitally reconstruct the work, preserving the original format whilst repairing imperfections present in the aged copy. In rare cases, an imperfection in the original, such as a blemish or missing page, may be replicated in our edition. We do, however, repair the vast majority of imperfections successfully; any imperfections that remain are intentionally left to preserve the state of such historical works.