Asset returns with transactions costs and uninsured individual risk

We explore whether incorporating an explicit motive for holding liquid assets within an equilibrium asset pricing model helps explain the following features of asset returns and turnover in the post-war U.S. economy: (i) the low, risk-free real interest rate, (ii) the large spread between returns on liquid assets and stocks, and (iii) the greater transaction velocity of liquid assets relative to stocks. We introduce a demand for liquid assets by adding uninsured individual risk together with differential costs of trading securities. Numerical simulations attempting to match the return data generate a ratio of liquid assets to income considerably below observed levels.