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Market liquidity, asset prices, and welfare

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  • Huang, Jennifer
  • Wang, Jiang
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    Abstract

    This paper represents an equilibrium model for the demand and supply of liquidity and its impact on asset prices and welfare. We show that, when constant market presence is costly, purely idiosyncratic shocks lead to endogenous demand of liquidity and large price deviations from fundamentals. Moreover, market forces fail to lead to efficient supply of liquidity, which calls for potential policy interventions. However, we demonstrate that different policy tools can yield different efficiency consequences. For example, lowering the cost of supplying liquidity on the spot (e.g., through direct injection of liquidity or relaxation of ex post margin constraints) can decrease welfare while forcing more liquidity supply (e.g., through coordination of market participants) can improve welfare.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 95 (2010)
    Issue (Month): 1 (January)
    Pages: 107-127

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    Handle: RePEc:eee:jfinec:v:95:y:2010:i:1:p:107-127

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Liquidity Asset prices Welfare Central bank policy;

    References

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    Cited by:
    1. Easley, David & O'Hara, Maureen, 2010. "Liquidity and valuation in an uncertain world," Journal of Financial Economics, Elsevier, vol. 97(1), pages 1-11, July.
    2. Liang, Samuel Xin & Wei, John K.C., 2012. "Liquidity risk and stock returns around the world," Journal of Banking & Finance, Elsevier, vol. 36(12), pages 3274-3288.

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