Liquidity and Market Structure

32 Pages Posted: 9 Jun 2004 Last revised: 23 May 2012

See all articles by Sanford J. Grossman

Sanford J. Grossman

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Merton H. Miller

University of Chicago - Booth School of Business

Date Written: July 1988

Abstract

Market liquidity is modeled as being determined by the demand and supply of immediacy. Exogenous liquidity events coupled with the risk of delayed trade create a demand for immediacy. Market makers supply immediacy by their continuous presence. and willingness to bear risk during the time period between the arrival of final buyers and sellers. In the long run the number of market makers adjusts to equate the supply and demand for immediacy. This determine the equilibrium level of liquidity in the market. The lower is the autocorrelation in rates of return, the higher is the equilibrium level of liquidity.

Suggested Citation

Grossman, Sanford J. and Miller, Merton H., Liquidity and Market Structure (July 1988). NBER Working Paper No. w2641. Available at SSRN: https://ssrn.com/abstract=227243

Sanford J. Grossman (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Merton H. Miller

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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