Asset Prices and Trading Volume Under Fixed Transactions Costs
Andrew W. Lo
Massachusetts Institute of Technology (MIT) - Sloan School of Management; Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL); National Bureau of Economic Research (NBER)
Massachusetts Institute of Technology (MIT) - Sloan School of Management; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER)
EFA 2001 Barcelona Meetings; Yale ICF Working Paper No. 00-35
We propose a dynamic equilibrium model of asset prices and trading volume with heterogeneous agents fixed transactions costs. We show that even small fixed costs can give rise to large "no-trade" regions for each agent's optimal trading policy and a significant illiquidity discount in asset prices. We perform a calibration exercise to illustrate the empirical relevance of our model for aggregate data. Our model also has implications for the dynamics of order flow, bid/ask spreads, market depth, the allocation of trading costs between buyers and sellers, and other aspects of market microstructure, including a square-root power law between trading volume and fixed costs which we confirm using historical US stock market data from 1993 to 1997.
Number of Pages in PDF File: 78
Keywords: Asset Pricing, Liquidity, Trading Volume, Transaction Costs
JEL Classification: G12working papers series
Date posted: June 7, 2001
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