Market Liquidity, Asset Prices, And Welfare

This paper presents an equilibrium model for the demand and supply of liquidity and its impact on asset prices and welfare. The author 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, they demonstrate that different policy tools can yield different efficiency consequences. For example, lowering the cost of supplying liquidity on the spot can improve welfare.