An Equilibrium Model for the Cross Section of Liquidity Premia
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AbstractWe study a risk-sharing economy where an arbitrary number of heterogeneous agents trades an arbitrary number of risky assets subject to quadratic transaction costs. For linear state dynamics, the forward–backward stochastic differential equations characterizing equilibrium asset prices and trading strategies in this context reduce to a coupled system of matrix-valued Riccati equations. We prove the existence of a unique global solution and provide explicit asymptotic expansions that allow us to approximate the corresponding equilibrium for small transaction costs. These tractable approximation formulas make it feasible to calibrate the model to time series of prices and trading volume, and to study the cross section of liquidity premia earned by assets with higher and lower trading costs. This is illustrated by an empirical case study.
Acceptance Date01/07/2022
All Author(s) ListJohannes Muhle-Karbe, Xiaofei Shi, Chen Yang
Journal nameMathematics of Operations Research
Year2023
Month8
Volume Number48
Issue Number3
Pages1423 - 1453
ISSN0364-765X
eISSN1526-5471
LanguagesEnglish-United Kingdom

Last updated on 2024-09-04 at 00:38