Financial-market Equilibrium with Friction

We show that the endogenous stochastic process of the liquidity of securities is as important to investment and valuation as the exogenous stochastic process of their cash flows. We develop a general-equilibrium model with heterogeneous investors who have an every-day motive to trade and pay transactions fees. Our model delivers the optimal, market-clearing moves of each investor and the resulting posted and transactions prices. We exhibit the effect of transactions fees on deviations from the consumption CAPM. We compare expected returns on stocks carrying different fees and evaluate the ability of various empirical liquidity measures to act as pricing proxies.