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

Topics:
Investment and Capital Markets
Tags:
Finance,
Investment,
Liquidity,
Transaction Cost
Source:
National Bureau of Economic Research

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Overview: The paper bridges the gap between Constantinides' theoretical result and the empirical magnitude of the liquidity premium by examining dynamic portfolio choice with transaction costs in a variety of more elaborate settings that move the problem closer to the one solved by real-world investors. In particular, the paper allows returns to be predictable and transaction costs to be stochastic, and introduces wealth shocks, both stationary multiplicative and labor income. With predictable returns, it also allows the wealth shocks and transaction costs to be state dependent.

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Format: PDF | Size: 503KB | Date: Dec 2004 | Pages: 51

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