Liquidity and Prices?

Question

Do fewer transaction costs and higher liquidity relate to lower market prices? Are there any good resources that deal with these topics in more detail?

Answer 1

I don't see how fewer transaction costs and higher liquidity would ever result in lower market prices. I haven't actually done any research on this matter, though I would suspect that it is the opposite to occur. For a stock to have lower transaction costs and greater liquidity, this would mean that the spread between bid and ask is much lower and an investor would feel much more confident that there will be 1. less volatility in the price action and 2. a greater ability to sell at the appropriate market price once one wants to sell. With that in mind, I would expect that the market price would actually be a bit higher with greater liquidity and fewer transaction costs - though again I don't have any research in this area of expertise, only from my personal experience and intuition.

I would consider it like a highly liquid real estate market. In Houston Texas or Toronto Canada, there are a large number of houses for sale and an incredible number of buyers and sellers for any transaction. As such, one can feel confident that closing costs would be lower (probably more realtors, lawyers, mortgage agents etc. in the industry to keep costs low) and also the bid-ask spread would be lower (a greater market size to absorb the housing inventory). For such a liquid market, a homeowner can feel confident they will get the true market value when they choose to sell. As such, from such confidence, I would expect home prices to be higher.