Adjusting the Volume: Counter-Cyclical Trading with Incomplete Markets

Abstract:     
While there is an extensive literature on asset pricing, there is very little theoretical or empirical work that analyzes the trading volume of assets. I find evidence that asset trade is counter-cyclical with respect to aggregate output. By proposing a general equilibrium model with incomplete markets and stochastic labor income shocks, this paper is able to replicate the patterns of trade found in the data, but also to analyze recent policies proposed to change access to equity markets and limit the amount of trading. The results point to a welfare loss to agents when their access is limited and that they switch to non regulated markets. Importantly, the model is able to reproduce an equity premium of 2.5%, which is much closer to the empirical level of 7% than comparable pricing models.

Keywords: Incomplete Markets, Asset Trading, Asset Pricing

JEL Classifications: G11, G12, G28, E21, E32

Working Paper Series