We investigate the effect of the regime-switching transaction costs and dividends to liquidity premia. Our numerical analysis shows that counter-cyclical transaction costs substantially raise liquidity premia while the pro-cyclical dividends amplify this effect. We also find that the expected transaction cost increases and the expected holding time decreases when illiquidity is counter-cyclical. This is because, while the dominating factor is the level of illiquidity and the width of the no-transaction region, the expected holding time is heavily affected by the regime switching intensity.

Keywords: Liquidity Premium; Portfolio Choice; Transaction Cost; Dividend; Illiquidity

JEL classification: D11; G11; C61​​