Transaction Costs, Frequent Trading, and Stock Prices.

Abstract

This study considers the effects of convex transaction costs on stock prices. These costs incite investors to trade frequently with relatively small amounts. Contrary to the existing articles which report that the strongest effects that transaction costs can have on the risk premium are of the order of a few percent, I find that the effects could be of the order of tens of percent conditioned that investors are sufficiently heterogeneous. Frequent trading in the presence of transaction costs substantially changes heterogeneity in demands across investors resulting in a significant liquidity premium. Furthermore, heterogeneity in transaction costs leads to a negative liquidity premium.

Keywords: Equilibrium, Asset Pricing, Transaction Costs

JEL Classification: G11, G12