Explaining the Magnitude of Liquidity Premia: The Roles of Return Predictability, Wealth Shocks, and State‐Dependent Transaction Costs

Anthony W. Lynch; Sinan Tan

doi:10.1111/j.1540-6261.2011.01662.x

Journal of Finance Vol. 66 No. 4 2011

Explaining the Magnitude of Liquidity Premia: The Roles of Return Predictability, Wealth Shocks, and State‐Dependent Transaction Costs

Anthony W. Lynch^1,2; Sinan Tan^{3,4,5,6,7,2,8}

¹ International Paper (United States) · ² New York University · ³ Fordham University · ⁴ Global Viral · ⁵ Sankt Hans Hospital · ⁶ Hasbro (United States) · ⁷ Department of Finance · ⁸ Rogers (United States)

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Abstract

Constantinides (1986) documents how the impact of transaction costs on per‐annum liquidity premia in the standard dynamic allocation problem with i.i.d. returns is an order of magnitude smaller than the cost rate itself. Recent papers form portfolios sorted on liquidity measures and find spreads in expected per‐annum return that are the same order of magnitude as the transaction cost spread. When we allow returns to be predictable and introduce wealth shocks calibrated to labor income, transaction costs are able to produce per‐annum liquidity premia that are the same order of magnitude as the transaction cost spread.

DOI: 10.1111/j.1540-6261.2011.01662.x
Volume: 66
Issue: 4
Pages: 1329-1368
Language: en
Sources: bibtex:phds-export.bib openalex crossref

Explaining the Magnitude of Liquidity Premia: The Roles of Return Predictability, Wealth Shocks, and State‐Dependent Transaction Costs

Abstract

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