Liquidity Premia and Transaction Costs

  title={Liquidity Premia and Transaction Costs},
  author={Bong-Gyu Jang and Hyeng Keun Koo and Hong Liu and Mark Loewenstein},
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… CONTINUE READING
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