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Asset Prices and Trading Volume under Fixed Transactions Costs

  • Andrew W. Lo
  • Harry Mamaysky
  • Jiang Wang

We propose a dynamic equilibrium model of asset prices and trading volume with heterogeneous agents facing fixed transactions costs. We show that even small fixed costs can give rise to large 'no-trade' regions for each agent's optimal trading policy and a significant illiquidity discount in asset prices. We perform a calibration exercise to illustrate the empirical relevance of our model for aggregate data. Our model also has implications for the dynamics of order flow, bid/ask spreads, market depth, the allocation of trading costs between buyers and sellers, and other aspects of market microstructure, including a square-root power law between trading volume and fixed costs which we confirm using historical US stock market data from 1993 to 1997.

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File URL: http://dx.doi.org/10.1086/422565
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File URL: http://dx.doi.org/10.1086/422565
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Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 112 (2004)
Issue (Month): 5 (October)
Pages: 1054-1090

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Handle: RePEc:ucp:jpolec:v:112:y:2004:i:5:p:1054-1090
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