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Equilibrium interest rate and liquidity premium with transaction costs

Vayanos, Dimitri and Vila, Jean-Luc (1999) Equilibrium interest rate and liquidity premium with transaction costs. Economic Theory, 13 (3). pp. 509-539. ISSN 1432-0479

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Identification Number: 10.1007/s001990050268


In this paper we study the effects of transaction costs on asset prices. We assume an overlapping generations economy with two riskless assets. The first asset is liquid while the second asset carries proportional transaction costs. We show that agents buy the liquid asset for short-term investment and the illiquid asset for long-term investment. When transaction costs increase, the price of the liquid asset increases. The price of the illiquid asset decreases if the asset is in small supply, but may increase if the supply is large. These results have implications for the effects of transaction taxes and commission deregulation.

Item Type: Article
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Divisions: LSE
Subjects: H Social Sciences > HB Economic Theory
Sets: Collections > Economists Online
Date Deposited: 09 Nov 2005
Last Modified: 20 Oct 2021 01:33

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