TY  - JOUR
AU  - Huang,Jennifer
AU  - Wang,Jiang
TI  - Market Liquidity, Asset Prices and Welfare
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 14058
PY  - 2008
Y2  - June 2008
UR  - http://www.nber.org/papers/w14058
L1  - http://www.nber.org/papers/w14058.pdf
N1  - Author contact info:
 jennifer_huang
Department of Finance, B6600
Red McCombs School of Business
University of Texas at Austin
Austin, TX 78712

Jiang Wang
MIT Sloan School of Management
100 Main Street, E62-614
Cambridge, MA 02142
Tel: 617/253-2632
Fax: 617/258-6855
E-Mail: wangj@mit.edu
AB  - This paper presents an equilibrium model for the demand and supply of liquidity and its impact on asset prices and welfare. We show that when constant market presence is costly, purely idiosyncratic shocks lead to endogenous demand of liquidity and large price deviations from fundamentals. Moreover, market forces fail to lead to efficient supply of liquidity, which calls for potential policy interventions. However, we demonstrate that different policy tools can yield different efficiency consequences. For example, lowering the cost of supplying liquidity on the spot (e.g., through direct injection of liquidity or relaxation of ex post margin constraints) can decrease welfare while forcing more liquidity supply (e.g., through coordination of market participants) can improve welfare.
ER  -