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Liquidity Premia in Dynamic Bargaining Markets

  • Pierre-Olivier Weill

This paper develops a search-theoretic model of the cross-sectional distribution of asset returns. It abstracts from risk premia and focuses exclusively on liquidity. A float-adjusted return model (FARM) is derived, explaining the pricing of liquidity with a simple linear formula: In equilibrium, the liquidity spread of an asset is proportional to the inverse of its dollar free-float. The dollar free-float is the portion of market capitalization available for sale. This suggests that dollar free-float is an appropriate measure of liquidity, consistent with the linear specifications commonly used in the empirical literature. The qualitative predictions of the model corroborates much of the empirical evidence. An analysis of the dynamic impact of news sheds light on time variation in liquidity

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File URL: http://pages.stern.nyu.edu/~pweill/papers/liquid_premia.pdf
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Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 648.

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Date of creation: 11 Aug 2004
Handle: RePEc:ecm:nawm04:648
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