Review of Financial Studies 28(7): 1914–1959, 2015
57 Pages Posted: 21 Oct 2010 Last revised: 17 Aug 2016
Date Written: March 1, 2014
This article studies how investors' differences of opinion affect liquidity and asset prices. We construct a dynamic general-equilibrium economy in which one population of excessively optimistic investors is subject to endogenous funding constraints that prevent default due to ex-ante limited commitment. When the funding constraint binds, optimists use their savings to increase their consumption share, in order to deter default. This higher consumption share lets them place speculative trades in the market place, increasing market liquidity. Because they generally lose on these trades, they become prone to default and the likelihood of funding constraints binding increases. We show that this joint feedback between funding illiquidity, disagreement and market liquidity is consistent with several empirically documented features of liquidity and financial asset prices.
Keywords: Differences of opinion, Funding liquidity, Market liquidity, Default, Stock return volatility
JEL Classification: G10, G12
Suggested Citation: Suggested Citation
Osambela, Emilio, Differences of Opinion, Endogenous Liquidity, and Asset Prices (March 1, 2014). Review of Financial Studies 28(7): 1914–1959, 2015. Available at SSRN: https://ssrn.com/abstract=1694330 or http://dx.doi.org/10.2139/ssrn.1694330