Liquidity in asset markets with search frictions
By: by Ricardo Lagos and Guillaume Rocheteau
Contributors: Rocheteau, Guillaume; Federal Reserve Bank of Cleveland
Series: Working paper -- WP07-06; Working paper (Federal Reserve Bank of Cleveland : Online) -- WP07-06.
Publisher: Federal Reserve Bank of Cleveland
Published: 2007
Place of publication: Cleveland, Ohio]
Language: eng
Format: [electronic resource] /
Description: "We study how trading frictions in asset markets affect the distribution of asset holdings, asset prices, efficiency, and standard measures of liquidity.  To this end, we analyze the equilibrium and optimal allocations of a search-theoretic model of financial intermediation similar to Duffie, Gârleanu and Pedersen (2005).  In contrast with the existing literature, the model we develop imposes no restrictions on asset holdings, so traders can accommodate frictions by varying their trading needs through changes in their asset positions.  We find that this is a critical aspect of investor behavior in illiquid markets.  A reduction in trading frictions leads to an increase in the dispersion of asset holdings and trade volume.  Transaction costs and intermediaries&rsquo; incentives to make markets are nonmonotonic in trade frictions.  With the entry of dealers, these nonmonotonicities give rise to an externality in liquidity provision that can lead to multiple equilibria.  Tight spreads are correlated with large volume and short trading delays across equilibria.  From a normative standpoint we show that the asset allocation across investors and the number of dealers are socially inefficient"--Federal Reserve Bank of Cleveland web site.
Notes: Title from PDF file as viewed on 10/29/2007.

Includes bibliographical references.

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