Explaining the magnitude of liquidity premia: the roles of return predictability, wealth shocks and state-dependent transaction costs
"The seminal work of Constantinides (1986) documents how, when the risky return is calibrated to the U.S. market return, the impact of transaction costs on per-annum liquidity premia is an order of magnitude smaller than the cost rate itself. A number of recent papers have formed portfolios sor...
Gespeichert in:
| Hauptverfasser: | , |
|---|---|
| Format: | Buch |
| Sprache: | English |
| Veröffentlicht: |
Cambridge, Mass.
National Bureau of Economic Research
2004
|
| Schriftenreihe: | National Bureau of Economic Research <Cambridge, Mass.>: NBER working paper series
10994 |
| Schlagworte: | |
| Online-Zugang: | Volltext |
| Zusammenfassung: | "The seminal work of Constantinides (1986) documents how, when the risky return is calibrated to the U.S. market return, the impact of transaction costs on per-annum liquidity premia is an order of magnitude smaller than the cost rate itself. A number of recent papers have formed portfolios sorted on liquidity measures and found a spread in expected per-annum return that is definitely not an order of magnitude smaller than the transaction cost spread: the expected per-annum return spread is found to be around 6-7% per annum. Our paper bridges the gap between Constantinides' theoretical result and the empirical magnitude of the liquidity premium by examining dynamic portfolio choice with transaction costs in a variety of more elaborate settings that move the problem closer to the one solved by real-world investors. In particular, we allow returns to be predictable and transaction costs to be stochastic, and we introduce wealth shocks, both stationary multiplicative and labor income. With predictable returns, we also allow the wealth shocks and transaction costs to be state dependent. We find that adding these real world complications to the canonical problem can cause transactions costs to produce per-annum liquidity premia that are no longer an order of magnitude smaller than the rate, but are instead the same order of magnitude. For example, predictable returns and i.i.d. labor income growth causes the liquidity premium for an agent with a wealth to monthly labor income ratio of 0 or 10 to be 1.68\% and 1.20\% respectively; these are 21-fold and 15-fold increases, respectively, relative to that in the standard i.i.d. return case. We conclude that the effect of proportional transaction costs on the standard consumption and portfolio allocation problem with i.i.d. returns can be materially altered by reasonable perturbations that bring the problem closer to the one investors are actually solving"--National Bureau of Economic Research web site. |
| Beschreibung: | 37, [12] S. graph. Darst. |
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| index_date | 2024-07-02T22:41:27Z |
| indexdate | 2024-07-09T21:25:10Z |
| institution | BVB |
| language | English |
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| series2 | National Bureau of Economic Research <Cambridge, Mass.>: NBER working paper series |
| spelling | Lynch, Anthony W. Verfasser (DE-588)12970959X aut Explaining the magnitude of liquidity premia the roles of return predictability, wealth shocks and state-dependent transaction costs Anthony W. Lynch ; Sinan Tan Cambridge, Mass. National Bureau of Economic Research 2004 37, [12] S. graph. Darst. txt rdacontent n rdamedia nc rdacarrier National Bureau of Economic Research <Cambridge, Mass.>: NBER working paper series 10994 "The seminal work of Constantinides (1986) documents how, when the risky return is calibrated to the U.S. market return, the impact of transaction costs on per-annum liquidity premia is an order of magnitude smaller than the cost rate itself. A number of recent papers have formed portfolios sorted on liquidity measures and found a spread in expected per-annum return that is definitely not an order of magnitude smaller than the transaction cost spread: the expected per-annum return spread is found to be around 6-7% per annum. Our paper bridges the gap between Constantinides' theoretical result and the empirical magnitude of the liquidity premium by examining dynamic portfolio choice with transaction costs in a variety of more elaborate settings that move the problem closer to the one solved by real-world investors. In particular, we allow returns to be predictable and transaction costs to be stochastic, and we introduce wealth shocks, both stationary multiplicative and labor income. With predictable returns, we also allow the wealth shocks and transaction costs to be state dependent. We find that adding these real world complications to the canonical problem can cause transactions costs to produce per-annum liquidity premia that are no longer an order of magnitude smaller than the rate, but are instead the same order of magnitude. For example, predictable returns and i.i.d. labor income growth causes the liquidity premium for an agent with a wealth to monthly labor income ratio of 0 or 10 to be 1.68\% and 1.20\% respectively; these are 21-fold and 15-fold increases, respectively, relative to that in the standard i.i.d. return case. We conclude that the effect of proportional transaction costs on the standard consumption and portfolio allocation problem with i.i.d. returns can be materially altered by reasonable perturbations that bring the problem closer to the one investors are actually solving"--National Bureau of Economic Research web site. Ökonometrisches Modell Investments Econometric models Tan, Sinan Verfasser (DE-588)129709603 aut Erscheint auch als Online-Ausgabe National Bureau of Economic Research <Cambridge, Mass.>: NBER working paper series 10994 (DE-604)BV002801238 10994 http://papers.nber.org/papers/w10994.pdf kostenfrei Volltext |
| spellingShingle | Lynch, Anthony W. Tan, Sinan Explaining the magnitude of liquidity premia the roles of return predictability, wealth shocks and state-dependent transaction costs National Bureau of Economic Research <Cambridge, Mass.>: NBER working paper series Ökonometrisches Modell Investments Econometric models |
| title | Explaining the magnitude of liquidity premia the roles of return predictability, wealth shocks and state-dependent transaction costs |
| title_auth | Explaining the magnitude of liquidity premia the roles of return predictability, wealth shocks and state-dependent transaction costs |
| title_exact_search | Explaining the magnitude of liquidity premia the roles of return predictability, wealth shocks and state-dependent transaction costs |
| title_exact_search_txtP | Explaining the magnitude of liquidity premia the roles of return predictability, wealth shocks and state-dependent transaction costs |
| title_full | Explaining the magnitude of liquidity premia the roles of return predictability, wealth shocks and state-dependent transaction costs Anthony W. Lynch ; Sinan Tan |
| title_fullStr | Explaining the magnitude of liquidity premia the roles of return predictability, wealth shocks and state-dependent transaction costs Anthony W. Lynch ; Sinan Tan |
| title_full_unstemmed | Explaining the magnitude of liquidity premia the roles of return predictability, wealth shocks and state-dependent transaction costs Anthony W. Lynch ; Sinan Tan |
| title_short | Explaining the magnitude of liquidity premia |
| title_sort | explaining the magnitude of liquidity premia the roles of return predictability wealth shocks and state dependent transaction costs |
| title_sub | the roles of return predictability, wealth shocks and state-dependent transaction costs |
| topic | Ökonometrisches Modell Investments Econometric models |
| topic_facet | Ökonometrisches Modell Investments Econometric models |
| url | http://papers.nber.org/papers/w10994.pdf |
| volume_link | (DE-604)BV002801238 |
| work_keys_str_mv | AT lynchanthonyw explainingthemagnitudeofliquiditypremiatherolesofreturnpredictabilitywealthshocksandstatedependenttransactioncosts AT tansinan explainingthemagnitudeofliquiditypremiatherolesofreturnpredictabilitywealthshocksandstatedependenttransactioncosts |