The hypothesis that financial markets punish traders who make relatively inaccurate forecasts and eventually eliminate the effect of their beliefs on prices is of fundamental importance to the standard modeling paradigm in asset pricing. We establish necessary and sufficient conditions for...

Milton Friedman argued that irrational traders will consistently lose money, won't survive and, therefore, cannot influence long run equilibrium asset prices. Since his work, survival and price influence have been assumed to be the same. Often partial equilibrium analysis has been relied upon to...

The performance of a given portfolio policy can in principle be evaluated by comparing its expected utility with that of the optimal policy. Unfortunately, the optimal policy is usually not computable in which case a direct comparison is impossible. In this paper we solve this problem by using...

We present a model of optimal allocation over liquid and illiquid assets, where illiquidity is the restriction that an asset cannot be traded for intervals of uncertain duration. Illiquidity leads to increased and state-dependent risk aversion, and reduces the allocation to both liquid and...

In this paper we survey the theoretical and empirical literature on market liquidity. We organize both literatures around three basic questions: (a) how to measure illiquidity, (b) how illiquidity relates to underlying market imperfections and other asset characteristics, and (c) how illiquidity...

We examine how liquidity and asset prices are affected by the following market imperfections: asymmetric information, participation costs, transaction costs, leverage constraints, non-competitive behavior and search. Our model has three periods: agents are identical in the first, become...

The supply/demand of a security in the market is an intertemporal, not a static, object and its dynamics is crucial in determining market participants' trading behavior. Previous studies on the optimal trading strategy to execute a given order focuses mostly on the static properties of the...

In this paper, we develop a methodology to identify money managers who have private information about future asset returns. The methodology does not rely on a specific risk model, such as the Sharpe ratio, CAPM, or APT. Instead, it relies on the observation that returns generated by managers...

We derive an intertemporal capital asset pricing model with multiple assets and heterogeneous investors, and explore its implications for the behavior of trading volume and asset returns. Assets contain two types of risks: market risk and the risk of changing market conditions. We show that...

We examine the implications of portfolio theory for the cross-sectional behavior of equity trading volume. Two-fund separation theorems suggest a natural definition for trading activity: share turnover. If two-fund separation holds, share turnover must be identical for all securities. If...