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Liquidity and Market Structure

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Author Info
Sanford J. Grossman
Merton H. Miller

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Abstract

Market liquidity is modeled as being determined by the demand and supply of immediacy. Exogenous liquidity events coupled with the risk of delayed trade create a demand for immediacy. Market makers supply immediacy by their continuous presence. and willingness to bear risk during the time period between the arrival of final buyers and sellers. In the long run the number of market makers adjusts to equate the supply and demand for immediacy. This determine the equilibrium level of liquidity in the market. The lower is the autocorrelation in rates of return, the higher is the equilibrium level of liquidity.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2641.

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Date of creation: Feb 1989
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Publication status: published as Journal of Finance, Vol. XLIII, No. 3, (July 1988), pp. 617-637.
Handle: RePEc:nbr:nberwo:2641

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Cohen, Kalman J, et al, 1981. "Transaction Costs, Order Placement Strategy, and Existence of the Bid-Ask Spread," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 287-305, April. [Downloadable!] (restricted)
  2. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March. [Downloadable!] (restricted)
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  3. Grossman, Sanford J, 1988. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," Journal of Business, University of Chicago Press, vol. 61(3), pages 275-98, July. [Downloadable!] (restricted)
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