Lapm: a Liquidity-Based Asset Pricing Model

72 Pages Posted: 11 Sep 1998 Last revised: 28 Mar 2021

See all articles by Bengt R. Holmström

Bengt R. Holmström

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Jean Tirole

University of Toulouse 1 - Industrial Economic Institute (IDEI); University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ); Centre for Economic Policy Research (CEPR)

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Date Written: August 1998

Abstract

The intertemporal CAPM predicts that an asset's price is equal to the expectation of the product of the asset's payoff and a representative consum substitution. This paper develops an alternative approach to asset pricing based on industrial and financial corporations' desire to hoard liquidity to fulfill future cash needs. Our corporate finance a determinants of asset prices such as the distribution of wealth within the corporate sector and between the corporate sector and the consumers. Also, leverage ratios, capital adequacy requirements, and the composition of savings affect the corporate demand for li The paper first sets up a general model of corporate demand for liquid assets, and obtains an explicit formula for the associated liquidity permia. It then derives some implications of corporate liquidity demand for the equity premium puzzle, for the yield curve, and for the state-contingent volatility of asset prices. Finally, the paper looks at some macroeconomic implications of the theory. It shows that government may be able to boost aggregate liquidity and enhance economic efficiency by promoting job and asset price stability. On the liability side, long-term deposits and equity investments, which depend on the consumers' endogenously determined liquidity needs, contribute to creating a feedback effect between employment prospects and equity-like investments. On the asset side, orderly sales of real estate by liquidity-squeezed institutions may generate a Pareto improvement

Suggested Citation

Holmström, Bengt R. and Tirole, Jean, Lapm: a Liquidity-Based Asset Pricing Model (August 1998). NBER Working Paper No. w6673, Available at SSRN: https://ssrn.com/abstract=123436

Bengt R. Holmström (Contact Author)

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Jean Tirole

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Centre for Economic Policy Research (CEPR)

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