Liquidity premium and the shape of transaction costs

Sergey Isaenko

Economic Modelling, 2025, vol. 152, issue C

Abstract: This article investigates a dynamic equilibrium in a competitive economy in which wealthy liquidity traders exchange stock shares with liquidity providers. Liquidity traders face bid–ask spreads when placing market orders, with spreads rising proportionally to the order size, modeled here using linear–quadratic transaction costs. Consistent with recent literature, the risk premium is several times larger than in a frictionless market due to a considerable reduction in liquidity traders’ trading demand. Interestingly, the liquidity premium is only weakly affected by the structure of transaction costs. Specifically, it remains virtually unchanged even as the weight of the linear component in transaction costs rises from zero to nearly 100%. The influence of transaction costs on stock prices arises primarily from heterogeneity among agents and their average trading frequency, which changes only marginally despite significant variations in the structure of transaction costs.

Keywords: General equilibrium; Liquidity; Liquidity premium; Transaction cost (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:152:y:2025:i:c:s0264999325002640

DOI: 10.1016/j.econmod.2025.107269

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