Endogenous Liquidity in Asset Markets
Andrea L. Eisfeldt
UCLA Anderson School of Management
Journal of Finance, Vol. 59, pp. 1-30, February 2004
This paper analyzes a model in which long-term risky assets are illiquid due to adverse selection. The degree of adverse selection and hence the liquidity of these assets is determined endogenously by the amount of trade for reasons other than private information. I find that higher productivity leads to increased liquidity. Moreover, liquidity magnifies the effects of changes in productivity on investment and volume. High productivity implies that investors initiate larger scale risky projects which increases the riskiness of their incomes. Riskier incomes induce more sales of claims to high-quality projects, causing liquidity to increase.
Number of Pages in PDF File: 46
Keywords: liquidity, adverse selection, dynamic adverse selection, business cycles
JEL Classification: E32, G00, D82
Date posted: February 28, 2004
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