This paper studies in a general framework the relative prices of perpetuities with identical dividends and different bid-ask spreads. It establishes four sets of conditions under which the liquidity premium is always positive (i.e., an asset with smaller spread always commands a higher price). To show that the liquidity premium is not necessarily positive, the paper presents two examples of general equilibrium in which the liquidity premium is sometimes negative. The paper also establishes four sets of conditions under which the price-spread relation is convex and uses results on asset price bubbles to establish liquidity premium bounds.
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Last update: July 19, 2001