Asset Prices and Liquidity with Market Power and Non-Gaussian Payoffs

Abstract

We consider an economy populated by strategic CARA investors who trade multiple risky assets with arbitrarily distributed payoffs. Our solution method reduces finding the equilibrium to solving a linear ordinary differential equation. With non-Gaussian payoffs: (i) asymmetry and nonlinearity of the price response to order imbalances are linked to higher moments of returns, in line with stylized facts; (ii) liquidity may be reduced when risk aversion or uncertainty decreases; (iii) market illiquidity is proportional to its risk-neutral variance; and (iv) illiquidity of individual assets is proportional to the risk-neutral covariance between returns earned by liquidity providers and asset returns.

BibTeX

@unpublished{GlebkinMalamudTeguia2020,
  author = {Glebkin, Sergei and Malamud, Semyon and Teguia, Alberto},
  title = {Asset Prices and Liquidity with Market Power and Non-{Gaussian} Payoffs},
  year = {2020},
  note = {Working paper},
  url = {https://sglebkin.com/GMT_CARA.pdf}
}