We propose a dynamic equilibrium model of asset prices and trading volume with heterogeneous
agents facing fixed transactions costs. We show that even small fixed costs can give
rise to large “no-trade” regions for each agent’s optimal trading policy and a significant illiquidity
discount in asset prices. We perform a calibration exercise to illustrate the empirical
relevance of our model for aggregate data. Our model also has implications for the dynamics
of order flow, bid/ask spreads, market depth, the allocation of trading costs between buyers
and sellers, and other aspects of market microstructure.
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