Asset prices and liquidity in an exchange economy

An asset-pricing model is developed, in which financial assets are valued for their liquidity—the extent to which they are useful in facilitating exchange—as well as for being claims to streams of consumption goods. The theory is used to study the implications of this liquidity channel for average asset returns, the equity-premium puzzle and the risk-free rate puzzle.

Research Highlights► The value of financial assets, e.g., equity shares, bonds, partly depends on the role that the assets play in exchange. ► An asset is liquid if it is generally accepted in exchange. ► Liquidity considerations can help to rationalize the equity premium puzzle and the risk-free rate puzzle.