Do fewer transaction costs and higher liquidity relate to lower market prices? Are there any good resources that deal with these topics in more detail?
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$\begingroup$ yes, why would they not lead to lower market prices. I assume you mean execution related costs when you say "market prices"? $\endgroup$– Matt WolfAug 3, 2013 at 2:26
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$\begingroup$ Yes exactly. I was just curious if there were good sources that go over the specifics. $\endgroup$– user5846Aug 3, 2013 at 3:04
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1$\begingroup$ Google TCA (transaction cost analysis model ) $\endgroup$– Matt WolfAug 3, 2013 at 6:11
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You are right, "exogeneous transaction costs" (transaction taxes, brokerage fees...) are related to illiquidity sources. In the literature, these costs impact prices because investors require compensation for its cost.
Empirically, liquidity has been helpful to explain some market facts such that the small firm effect, the equity premium puzzle... Loosely speaking if you are interested in good material you have the choice either to study the literature (very large) on market microstructure or the literature on liquidity and asset pricing. In this latter literature, the market is seen as a friction market and illiquidity costs (frictions) are taken into accounts by investors. Then, returns (=prices) are impacted by illiquidity. A very good introduction to this literature is given in : Amihud, Y., Mendelson, H., & Heje Pedersen, L. (2005). Liquidity and Asset Prices . nowpublishers Inc.
Two others references :
Acharya, V., & Pedersen, L. (2005). Asset pricing with liquidity risk. Journal of Financial Economics,
Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid-ask spread. Journal of financial Economics, 17.
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$\begingroup$ Moreover, since a) liquidity change over time and b) liquidity impact returns ; then a+b= liquidity also impact assets volatility. $\endgroup$– MalickJan 20, 2014 at 3:15