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Asset Prices and Trading Volume Under Fixed Transactions CostsAndrew W. LoMassachusetts 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) Harry MamayskyYale School of Management Jiang WangMassachusetts Institute of Technology (MIT) - Sloan School of Management; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER) May 2001 NBER Working Paper No. w8311 Abstract: We propose a dynamic equilibrium model of asset prices and trading volume with heterogeneous agents facing 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 working papers seriesDate posted: June 3, 2001Suggested CitationContact Information
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