Liquidity and market incompleteness (original) (raw)
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cl LIQUIDITY AND MARKET INCOMPLETENESS
2007
This note shows that according to Lipmann and McCall's (1986) operational de…nition of liquidity, incomplete markets are a necessary condition for illiquidity.
We survey the theoretical literature on market liquidity. The literature traces illiquidity, i.e., the lack of liquidity, to underlying market imperfections. We consider six main imperfections: participation costs, transaction costs, asymmetric information, imperfect competition, funding constraints, and search. We address three questions in the context of each imperfection: (a) how to measure illiquidity, (b) how illiquidity relates to underlying market imperfections and other asset characteristics, and (c) how illiquidity affects expected asset returns. We nest all six imperfections within a common, unified model, and use that model to organize the literature.
Does Market Incompleteness Matter
2001
This paper argues that incompleteness of intertemporal financia l markets has little effect (on welfare, prices, or consumptions) in an economy with a single consumption good, provided that traders are long-lived and patient, a riskless bond is traded, shocks are transitory, and there is no aggregate risk. In an economy with aggregate risk, a similar conclusion holds, provided traders
Journal of Mathematical Economics, 1996
We adapt an elegant piece of reasoning by Y. Balasko [Balasko, Y., 1979. Economies with a finite but large number of equilibria. J. Math. Econ. 6, 145–147.] to the incomplete markets modelled by D. Duffie and W. Shafer [Duffie, D., Shafer, W., 1985. Equilibrium in incomplete markets: I. A basic model of generic existence. J. Math. Econ. 14, 285–300.], and prove that on compact sets of such markets, the Lebesgue measure of economies with m equilibria is O().
Journal of Economic Theory, 2018
We propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity. We analyze economies with complete and incomplete financial markets and/or restricted trading possibilities in the form of borrowing limits or transaction costs. We describe circumstances under which various restrictions on financial markets are desirable according to our welfare criterion.
Liquidity and Asset Prices: A Unified Framework
2009
We examine how liquidity and asset prices are affected by the following market imperfections: asymmetric information, participation costs, transaction costs, leverage constraints, non-competitive behavior and search. Our model has three periods: agents are identical in the first, become heterogeneous and trade in the second, and consume asset payoffs in the third.
A Case for Incomplete Markets Lawrence Blume
2018
We propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity. We analyze economies with complete and incomplete financial markets and/or restricted trading possibilities in the form of borrowing limits or transaction costs. We describe circumstances under which various restrictions on financial markets are desirable according to our welfare criterion.
Complete and incomplete markets with short-sale constraints
2003
This paper argues that the introduction of a short-sale constraint in the Arrow-Radner framework invalidates standard definitions of complete and incomplete markets. In this constrained set-up, two threshold values with familiar properties arise. The case of a zero short-sale bound set on some security fulfills the standard definition of "incomplete" financial markets. Beyond a particular level of the short-sale bound financial markets are "complete", since the short-sale constraint is not active. For intermediate bounds the distinction between complete and incomplete financial markets is blurred. Although some technical definitions hold, agents can not fully transfer wealth among states. These intermediate cases, called "technically incomplete markets", exhibit interesting welfare properties. For instance, the resulting equilibrium allocations may not be Pareto dominated by those of the non-restricted complete markets equilibrium. The discussions with Narayana Kocherlakota and Edward Green have inspired this work. I thank David Cass for useful insights.
Theory-Based Illiquidity and Asset Pricing
Review of Financial Studies, 2009
Many proxies of illiquidity have been used in the literature that relates illiquidity to asset prices. These proxies have been motivated from an empirical standpoint. In this study, we approach liquidity estimation from a theoretical perspective. Our method explicitly recognizes the analytic dependence of illiquidity on more primitive drivers such as trading activity and information asymmetry. More specifically, we estimate illiquidity using structural formulae in line with lambda for a comprehensive sample of stocks. The empirical results provide convincing evidence that theory-based estimates of illiquidity are priced in the cross-section of expected stock returns, even after accounting for risk factors, firm characteristics known to influence returns, and other illiquidity proxies prevalent in the literature. the context of Kyle lambdas. Section 2 describes the methodology. Section 3 outlines the data, definitions, and descriptive statistics. Section 4 discusses the empirical results and robustness checks. In Section 5, we compare the effects of the theory-based measures with those of other alternative (il)liquidity measures. Section 6 concludes.