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Market Liquidity - Theory and Empirical Evidence

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  • Dimitri Vayanos

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  • Jiang Wang

Abstract

In this paper we survey the theoretical and empirical literature on market liquidity. We organize both literatures around three basic questions: (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. Using a unified model from Vayanos and Wang (2010), we survey theoretical work on six main imperfections: participation costs, transaction costs, asymmetric information, imperfect competition, funding constraints, and search—and for each imperfection we address the three basic questions within that model. We review the empirical literature through the lens of the theory, using the theory to both interpret existing results and suggest new tests and analysis.

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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp709.

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Date of creation: Jul 2012
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Handle: RePEc:fmg:fmgdps:dp709

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Keywords: market liquidity; market imperfections; illiquidity measures; illiquidity and expected returns;

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