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http://ssrn.com/abstract=1009568
 
 

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Market Liquidity, Asset Prices, and Welfare


Jennifer C. Huang


University of Texas at Austin - Department of Finance

Jiang Wang


MIT; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER)

August 1, 2008

McCombs School of Business Research Paper No. FIN-05-08
AFA 2009 San Francisco Meetings Paper

Abstract:     
This paper presents an equilibrium model for the demand and supply of liquidity and its impact on asset prices and welfare. We show that when constant market presence is costly, purely idiosyncratic shocks lead to endogenous demand of liquidity and large price deviations from fundamentals. Moreover, market forces fail to lead to efficient supply of liquidity, which calls for potential policy interventions. However, we demonstrate that different policy tools can yield different efficiency consequences. For example, lowering the cost of supplying liquidity on the spot (e.g., through direct injection of liquidity or relaxation of ex post margin constraints) can decrease welfare while forcing more liquidity supply (e.g., through coordination of market participants) can improve welfare.

Number of Pages in PDF File: 43

Keywords: liquidity, transaction costs, asset prices, welfare

JEL Classification: D52, D62, G12

working papers series


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Date posted: August 25, 2007 ; Last revised: September 11, 2009

Suggested Citation

Huang, Jennifer C. and Wang, Jiang, Market Liquidity, Asset Prices, and Welfare (August 1, 2008). McCombs School of Business Research Paper No. FIN-05-08; AFA 2009 San Francisco Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1009568 or http://dx.doi.org/10.2139/ssrn.1009568

Contact Information

Jennifer Chunyan Huang (Contact Author)
University of Texas at Austin - Department of Finance ( email )
McCombs School of Business, B6600
Austin, TX 78712
United States
512-232-9375 (Phone)
512-471-5073 (Fax)
Jiang Wang
MIT ( email )
E62-614
100 Main Street
Cambridge, MA 02142
United States
617-253-2632 (Phone)
617-258-6855 (Fax)
China Academy of Financial Research (CAFR)
1954 Huashan Road
Shanghai P.R.China, 200030
China

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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