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The effect of regime-switching transaction costs and cash dividends on liquidity premia

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  • Chae, Jiwon
  • Jang, Bong-Gyu
  • Kim, Taeyoon

Abstract

We investigate the effect of the regime-switching transaction costs and dividends on liquidity premium and investor’s optimal strategy. With reasonably calibrated parameters, we show that counter-cyclical transaction costs substantially raise liquidity premium while pro-cyclical dividends amplify this effect. More importantly, we observe that cash dividends can no longer play a role as a liquidity provider if the volatility of pro-cyclical dividends increases. Our model provides a universal framework in the liquidity contexts, so that we can examine the effect of regime switching on liquidity premium for all combinations of regimes in transaction costs and dividends.

Suggested Citation

  • Chae, Jiwon & Jang, Bong-Gyu & Kim, Taeyoon, 2024. "The effect of regime-switching transaction costs and cash dividends on liquidity premia," International Review of Financial Analysis, Elsevier, vol. 93(C).
    • Handle: RePEc:eee:finana:v:93:y:2024:i:c:s1057521924001182
    DOI: 10.1016/j.irfa.2024.103186
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    More about this item

    Keywords

    Liquidity premium; Portfolio choice; Transaction cost; Dividend; Regime switch;
    All these keywords.

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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