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Theories of Liquidity

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  • Vayanos, Dimitri
  • Wang, Jiang

Abstract

We survey the theoretical literature on market liquidity. The literature traces illiquidity, i.e., the lack of liquidity, to underlying market imperfections. We consider six main imperfections: participation costs, transaction costs, asymmetric information, imperfect competition, funding constraints, and search. We address three questions in the context of each imperfection: (a) how to measure illiquidity, (b) how illiquidity relates to underlying market imperfections and other asset characteristics, and (c) how illiquidity affects expected asset returns. We nest all six imperfections within a common, unified model, and use that model to organize the literature.

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File URL: http://dx.doi.org/10.1561/0500000014
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Bibliographic Info

Article provided by now publishers in its journal Foundations and Trends(R) in Finance.

Volume (Year): 6 (2012)
Issue (Month): 4 (November)
Pages: 221-317

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Handle: RePEc:now:fntfin:0500000014

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Web page: http://www.nowpublishers.com/

Related research

Keywords: Liquidity; Market imperfections; Asymmetric information; Market microstructure;

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Cited by:
  1. Banerjee, Snehal & Graveline, Jeremy J., 2014. "Trading in derivatives when the underlying is scarce," Journal of Financial Economics, Elsevier, Elsevier, vol. 111(3), pages 589-608.

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