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Liquidity premium and the shape of transaction costs

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  • Isaenko, Sergey

Abstract

This article investigates a dynamic equilibrium in a competitive economy in which wealthy liquidity traders exchange stock shares with liquidity providers. Liquidity traders face bid–ask spreads when placing market orders, with spreads rising proportionally to the order size, modeled here using linear–quadratic transaction costs. Consistent with recent literature, the risk premium is several times larger than in a frictionless market due to a considerable reduction in liquidity traders’ trading demand. Interestingly, the liquidity premium is only weakly affected by the structure of transaction costs. Specifically, it remains virtually unchanged even as the weight of the linear component in transaction costs rises from zero to nearly 100%. The influence of transaction costs on stock prices arises primarily from heterogeneity among agents and their average trading frequency, which changes only marginally despite significant variations in the structure of transaction costs.

Suggested Citation

  • Isaenko, Sergey, 2025. "Liquidity premium and the shape of transaction costs," Economic Modelling, Elsevier, vol. 152(C).
    • Handle: RePEc:eee:ecmode:v:152:y:2025:i:c:s0264999325002640
    DOI: 10.1016/j.econmod.2025.107269
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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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