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Theories of Liquidity

Author

Listed:
  • 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.

Suggested Citation

  • Vayanos, Dimitri & Wang, Jiang, 2012. "Theories of Liquidity," Foundations and Trends(R) in Finance, now publishers, vol. 6(4), pages 221-317, November.
  • Handle: RePEc:now:fntfin:0500000014
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    File URL: http://dx.doi.org/10.1561/0500000014
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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, vol. 111(3), pages 589-608.

    More about this item

    Keywords

    Liquidity; Market imperfections; Asymmetric information; Market microstructure;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G - Financial Economics
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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