Premium
Liquidity Premia and Transaction Costs
Author(s) -
JANG BONGGYU,
KEUN KOO HYENG,
LIU HONG,
LOEWENSTEIN MARK
Publication year - 2007
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2007.01277.x
Subject(s) - transaction cost , market liquidity , liquidity premium , economics , investment (military) , order (exchange) , equity (law) , consumption (sociology) , database transaction , monetary economics , microeconomics , econometrics , financial economics , liquidity risk , finance , computer science , social science , programming language , sociology , politics , law , political science
Standard literature concludes that transaction costs only have a second‐order effect on liquidity premia. We show that this conclusion depends crucially on the assumption of a constant investment opportunity set. In a regime‐switching model in which the investment opportunity set varies over time, we explicitly characterize the optimal consumption and investment strategy. In contrast to the standard literature, we find that transaction costs can have a first‐order effect on liquidity premia. However, with reasonably calibrated parameters, the presence of transaction costs still cannot fully explain the equity premium puzzle.