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Market Liquidity—Theory and Empirical Evidence

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  • Vayanos, Dimitri
  • Wang, Jiang

Abstract

In this paper we survey the theoretical and empirical literatures 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.

Suggested Citation

  • Vayanos, Dimitri & Wang, Jiang, 2013. "Market Liquidity—Theory and Empirical Evidence ," Handbook of the Economics of Finance, Elsevier.
  • Handle: RePEc:eee:finchp:2-b-1289-1361
    DOI: 10.1016/B978-0-44-459406-8.00019-6
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    1. Adam, Klaus & Beutel, Johannes & Marcet, Albert & Merkel, Sebastian, 2015. "Can a financial transaction tax prevent stock price booms?," Journal of Monetary Economics, Elsevier, vol. 76(S), pages 90-109.
    2. repec:eee:riibaf:v:41:y:2017:i:c:p:220-234 is not listed on IDEAS
    3. Capelle-Blancard, Gunther, 2017. "Curbing the growth of stock trading? Order-to-trade ratios and financial transaction taxes," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 49(C), pages 48-73.

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