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Equilibrium interest rate and liquidity premium with transaction costs

Author

Listed:
  • Jean-Luc Vila

    (Convergence Asset Management, 475 Steamboat Road, Greenwich, CT 06830, USA)

  • Dimitri Vayanos

    (MIT Sloan School of Management, 50 Memorial Drive E52-437, Cambridge, MA 02142, USA)

Abstract

In this article we study the effects of transaction costs on asset prices. We assume an overlapping generations economy with two riskless assets. The first asset is liquid while the second asset carries proportional transaction costs. We show that agents buy the liquid asset for short-term investment and the illiquid asset for long-term investment. When transaction costs increase, the price of the liquid asset increases. The price of the illiquid asset decreases if the asset is in small supply, but may increase if the supply is large. These results have implications for the effects of transaction taxes and commission deregulation.

Suggested Citation

  • Jean-Luc Vila & Dimitri Vayanos, 1999. "Equilibrium interest rate and liquidity premium with transaction costs," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 13(3), pages 509-539.
    • Handle: RePEc:spr:joecth:v:13:y:1999:i:3:p:509-539
    Note: Received: December 5, 1997; revised version: March 19, 1998
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    References listed on IDEAS

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    1. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    2. Aiyagari, S. Rao & Gertler, Mark, 1991. "Asset returns with transactions costs and uninsured individual risk," Journal of Monetary Economics, Elsevier, vol. 27(3), pages 311-331, June.
    3. Jeffrey A. Frankel, 1994. "The Internationalization of Equity Markets," NBER Books, National Bureau of Economic Research, Inc, number fran94-1, March.
    4. Aiyagari, S. Rao & Gertler, Mark, 1991. "Asset returns with transactions costs and uninsured individual risk," Journal of Monetary Economics, Elsevier, vol. 27(3), pages 311-331, June.
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    More about this item

    Keywords

    Transaction costs Asset pricing · General equilibrium · Overlapping generations. ·;

    JEL classification:

    • J1 - Labor and Demographic Economics - - Demographic Economics

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