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Liquidity and Market Structure

Author

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  • Sanford J. Grossman
  • Merton H. Miller

Abstract

Market liquidity is modeled as being determined by the demand and supply of immediacy. Exogenous liquidity events coupled with the risk of delayed trade create a demand for immediacy. Market makers supply immediacy by their continuous presence. and willingness to bear risk during the time period between the arrival of final buyers and sellers. In the long run the number of market makers adjusts to equate the supply and demand for immediacy. This determine the equilibrium level of liquidity in the market. The lower is the autocorrelation in rates of return, the higher is the equilibrium level of liquidity.

Suggested Citation

  • Sanford J. Grossman & Merton H. Miller, 1988. "Liquidity and Market Structure," NBER Working Papers 2641, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:2641
    Note: ME
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    References listed on IDEAS

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    1. Grossman, Sanford J, 1988. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," The Journal of Business, University of Chicago Press, vol. 61(3), pages 275-298, July.
    2. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
    3. Harold Demsetz, 1968. "The Cost of Transacting," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 82(1), pages 33-53.
    4. Cohen, Kalman J & Maier, Steven F & Schwartz, Robert A & Whitcomb, David K, 1981. "Transaction Costs, Order Placement Strategy, and Existence of the Bid-Ask Spread," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 287-305, April.
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