Handbook of the Economics of Finance

Chapter 19

Market Liquidity—Theory and Empirical Evidence ^*

Dimitri Vayanos^a and Jiang Wang^b

^aDimitri Vayanos, Department of Finance, London School of Economics, London WC2A 2AE, United Kingdom, CEPR and NBER

^bSloan School of Management, Massachusetts Institute of Technology, Cambridge MA 02142, USA, CAFR and NBER, [e-mail]

Abstract

In this paper we survey the theoretical and empirical literatures on market liquidity. We organize both literatures around three basic questions: (a) how to measure illiquidity, (b) how illiquidity relates to underlying market imperfections and other asset characteristics, and (c) how illiquidity affects expected asset returns. Using a unified model from Vayanos and Wang (2010), we survey theoretical work ...