Asset Returns with Transactions Cost and Uninsured Risk: A Stage III Exercise

(iii) Transaction velocities are much higher for liquid assets than for stocks, specifically, we explore the extent to which incorporating an explicit motive for holding liquid assets can explain the above observations. We introduce a demand for liquid assets by adding uninsured individual risk together with differential costs of trading securities. We then parameterize a class of such models and compute the stationary equilibria. The simulations indicate that attempting to match the return data generates a ratio of liquid assets to income considerably be low observed levels. We then explore some possible reasons for this discrepancy.