Liquidity Premia in Dynamic Bargaining Markets

Darrell Duffie

No 634, Econometric Society 2004 North American Winter Meetings from Econometric Society

Abstract: This paper develops a search-theoretic model of the cross-sectional distribution of asset returns. It abstracts from risk premia and focuses exclusively on liquidity. A float-adjusted return model (FARM) is derived, explaining the pricing of liquidity with a simple linear formula: In equilibrium, the liquidity spread of an asset is proportional to the inverse of its dollar free-float. The dollar free-float is the portion of market capitalization available for sale. This suggests that dollar free-float is an appropriate measure of liquidity, consistent with the linear specifications commonly used in the empirical literature. The qualitative predictions of the model corroborates much of the empirical evidence. An analysis of the dynamic impact of news sheds light on time variation in liquidity. --------------------------------------------------------------------------------

Keywords: search; liquidity premia (search for similar items in EconPapers)
JEL-codes: C78 G12 (search for similar items in EconPapers)
Date: 2004-08-11
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Persistent link: https://EconPapers.repec.org/RePEc:ecm:nawm04:634

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