Theories of Liquidity

111 Pages Posted: 23 May 2013

See all articles by Dimitri Vayanos

Dimitri Vayanos

London School of Economics; Center for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Jiang Wang

Massachusetts Institute of Technology (MIT) - Sloan School of Management; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER)

Date Written: 2011

Abstract

We survey the theoretical literature on market liquidity. The literature traces illiquidity, i.e., the lack of liquidity, to underlying market imperfections. We consider six main imperfections: participation costs, transaction costs, asymmetric information, imperfect competition, funding constraints, and search. We address three questions in the context of each imperfection: (a) how to measure illiquidity, (b) how illiquidity relates to underlying market imperfections and other asset characteristics, and (c) how illiquidity affects expected asset returns. We nest all six imperfections within a common, unified model, and use that model to organize the literature.

Keywords: liquidity, market imperfections, asymmetric information, market microstructure

JEL Classification: G10, G14, G, L13

Suggested Citation

Vayanos, Dimitri and Wang, Jiang, Theories of Liquidity (2011). Foundations and Trends in Finance, Vol. 6, No. 4, 2011, Available at SSRN: https://ssrn.com/abstract=2268580

Dimitri Vayanos (Contact Author)

London School of Economics ( email )

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Center for Economic Policy Research (CEPR)

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Jiang Wang

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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China Academy of Financial Research (CAFR)

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National Bureau of Economic Research (NBER)

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