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Liquidity and Market Structure

Sanford J. Grossman and Merton H. Miller
The Journal of Finance
Vol. 43, No. 3, Papers and Proceedings of the Forty-Seventh Annual Meeting of the American Finance Association, Chicago, Illinois, December 28-30, 1987 (Jul., 1988), pp. 617-633
Published by: Wiley for the American Finance Association
DOI: 10.2307/2328186
Stable URL: http://www.jstor.org/stable/2328186
Page Count: 17
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Liquidity and Market Structure
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Abstract

Market liquidity is modeled as being determined by the demand and supply of immediacy. Exogenous liquidity events coupled with the risk of delayed trade create a demand for immediacy. Market makers supply immediacy by their continuous presence and willingness to bear risk during the time period between the arrival of final buyers and sellers. In the long run the number of market makers adjusts to equate the supply and demand for immediacy. This determines the equilibrium level of liquidity in the market. The lower is the autocorrelation in rates of return, the higher is the equilibrium level of liquidity.

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