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LAPM: A Liquidity Based Asset Pricing Model

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  • Bengt Holmstrom
  • Jean Tirole

Abstract

The intertemporal CAPM predicts that an asset's price is equal to the expectation of the product of the asset's payoff and a representative consum substitution. This paper develops an alternative approach to asset pricing based on industrial and financial corporations' desire to hoard liquidity to fulfill future cash needs. Our corporate finance a determinants of asset prices such as the distribution of wealth within the corporate sector and between the corporate sector and the consumers. Also, leverage ratios, capital adequacy requirements, and the composition of savings affect the corporate demand for li The paper first sets up a general model of corporate demand for liquid assets, and obtains an explicit formula for the associated liquidity permia. It then derives some implications of corporate liquidity demand for the equity premium puzzle, for the yield curve, and for the state-contingent volatility of asset prices. Finally, the paper looks at some macroeconomic implications of the theory. It shows that government may be able to boost aggregate liquidity and enhance economic efficiency by promoting job and asset price stability. On the liability side, long-term deposits and equity investments, which depend on the consumers' endogenously determined liquidity needs, contribute to creating a feedback effect between employment prospects and equity-like investments. On the asset side, orderly sales of real estate by liquidity-squeezed institutions may generate a Pareto improvement
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Suggested Citation

  • Bengt Holmstrom & Jean Tirole, 1998. "LAPM: A Liquidity Based Asset Pricing Model," Working papers 98-8, Massachusetts Institute of Technology (MIT), Department of Economics.
  • Handle: RePEc:mit:worpap:98-8
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    Cited by:

    1. Stephen Morris & Hyun Song Shin, 2004. "Liquidity Black Holes," Review of Finance, European Finance Association, vol. 8(1), pages 1-18.
    2. Fernando A. Broner & Guido Lorenzoni & Sergio L. Schmukler, 2013. "Why Do Emerging Economies Borrow Short Term?," Journal of the European Economic Association, European Economic Association, vol. 11, pages 67-100, January.
    3. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 111(3), pages 642-685, June.
    4. Al-Jarhi, Mabid Ali, 2004. "Remedy For Banking Crises: What Chicago And Islam Have In Common: A Comment," Islamic Economic Studies, The Islamic Research and Training Institute (IRTI), vol. 11, pages 24-42.
    5. OUATTARA, Aboudou, 2016. "Impact of the transition to continous trading on emerging financial market's liquidity : Case study of the West Africa Regional Exchange Market (BRVM)," MPRA Paper 75391, University Library of Munich, Germany.
    6. Drew Saunders, 2009. "The Elastic Provision of Liquidity by Private Agents," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(7), pages 1423-1451, October.
    7. Anil K. Kashyap & Raghuram Rajan & Jeremy C. Stein, 2002. "Banks as Liquidity Providers: An Explanation for the Coexistence of Lending and Deposit-Taking," Journal of Finance, American Finance Association, vol. 57(1), pages 33-73, February.
    8. Rubio Irigoyen, Gonzalo & Martínez Sedano, Miguel Angel & Nieto, Belén, 2002. "Asset pricing and systematic liquidity risk: an empirical investigation of the Spanish stock market," DFAEII Working Papers 2002-05, University of the Basque Country - Department of Foundations of Economic Analysis II.
    9. Rui Albuquerue & Neng Wang, 2008. "Agency Conflicts, Investment, and Asset Pricing," Journal of Finance, American Finance Association, vol. 63(1), pages 1-40, February.
    10. Francis A. Longstaff, 2004. "The Flight-to-Liquidity Premium in U.S. Treasury Bond Prices," The Journal of Business, University of Chicago Press, vol. 77(3), pages 511-526, July.
    11. Acharya, Viral V. & Pedersen, Lasse Heje, 2005. "Asset pricing with liquidity risk," Journal of Financial Economics, Elsevier, vol. 77(2), pages 375-410, August.
    12. Geert Bekaert & Campbell R. Harvey & Christian Lundblad, 2007. "Liquidity and Expected Returns: Lessons from Emerging Markets," Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 1783-1831, November.
    13. Francis A. Longstaff, 2004. "Financial Claustrophobia: Asset Pricing in Illiquid Markets," NBER Working Papers 10411, National Bureau of Economic Research, Inc.
    14. Matthew Pritsker, 2005. "Large investors: implications for equilibrium asset, returns, shock absorption, and liquidity," Finance and Economics Discussion Series 2005-36, Board of Governors of the Federal Reserve System (U.S.).
    15. Herrera, Santiago & Perry, Guillermo, 2001. "Tropical bubbles : asset prices in Latin America, 1980-2001," Policy Research Working Paper Series 2724, The World Bank.
    16. Miquel Faig & Pauline Shum, 2002. "Portfolio Choice in the Presence of Personal Illiquid Projects," Journal of Finance, American Finance Association, vol. 57(1), pages 303-328, February.
    17. Eduardo Siandra, 2002. "The Economics of financial Matching," Documentos de Trabajo (working papers) 1002, Department of Economics - dECON.
    18. Herrala, Risto, 2003. "The rigidity bias," Research Discussion Papers 31/2003, Bank of Finland.
    19. Balázs Romhányi, 2005. "A learning hypothesis of the term structure of interest rates," Macroeconomics 0503001, EconWPA.
    20. Iichiro Uesugi & Guy M. Yamashiro, 2003. "On the Relationship Between the Very Short Forward and the Spot Interest Rate," Discussion papers 03013, Research Institute of Economy, Trade and Industry (RIETI).

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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