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Asset Prices and Trading Volume Under Fixed Transactions Costs

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  • Andrew Lo
  • Harry Mamaysky
  • Jiang Wang

Abstract

We propose a dynamic equilibrium model of asset prices and trading volume with heterogeneous agents fixed transactions costs. We show that even small fixed costs can give rise to large "no-trade" regions for each agent's optimal trading policy and a significant illiquidity discount in asset prices. We perform a calibration exercise to illustrate the empirical relevance of our model for aggregate data. Our model also has implications for the dynamics of order flow, bid/ask spreads, market depth, the allocation of trading costs between buyers and sellers, and other aspects of market microstructure, including a square-root power law between trading volume and fixed costs which we confirm using historical US stock market data from 1993 to 1997.

Suggested Citation

  • Andrew Lo & Harry Mamaysky & Jiang Wang, 2001. "Asset Prices and Trading Volume Under Fixed Transactions Costs," Yale School of Management Working Papers ysm188, Yale School of Management, revised 01 Sep 2009.
    • Handle: RePEc:ysm:somwrk:ysm188
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    File URL: http://icfpub.som.yale.edu/publications/2403
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    Keywords

    Asset Pricing; Liquidity; Trading Volume; Transaction Costs;
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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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