NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Financial Claustrophobia: Asset Pricing in Illiquid Markets

Francis A. Longstaff

NBER Working Paper No. 10411
Issued in April 2004
NBER Program(s):   AP

There are many examples of markets where an agent who wants to get out of an investment position quickly may find himself trapped and forced to remain in that position because of a lack of liquidity. What are the asset-pricing implications when agents cannot always buy and sell assets immediately? We study this issue in a multi-asset exchange economy with heterogeneous agents. In this model, agents can trade initially, but then cannot trade again until after a trading blackout' period. The more liquid the market, the sooner agents can trade again. Faced with illiquidity, agents abandon diversification and choose highly polarized portfolios. Risky assets are held primarily by the less-patient short-horizon agents in the economy. Polarization causes the usual risk-return tradeo. to break down and an asset's price may have more to do with the demographics of who owns it than with the riskiness of its cash flows. Risky assets are generally more valuable in an illiquid market than in a liquid market. Market illiquidity can also have large effects on the equity premium.

download in pdf format
   (322 K)

email paper

This paper is available as PDF (322 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w10411

Users who downloaded this paper also downloaded these:
Schwartz and Tebaldi w12633 Illiquid Assets and Optimal Portfolio Choice
Kahl, Liu, and Longstaff w8969 Paper millionaires: How valuable is stock to a stockholder who is restricted from selling it?
Lagos, Rocheteau, and Weill w14119 Crashes and Recoveries in Illiquid Markets
Vayanos w10327 Flight to Quality, Flight to Liquidity, and the Pricing of Risk
Longstaff, Mithal, and Neis w10418 Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us