'Price Barriers' and the Dynamics of Asset Prices in Equilibrium

Abstract:     
In a variety of realistic scenarios, some investors trade infrequently rather than continuously, basing their buy or sell decisions on current price levels. A "price barrier" is a price level at which a large number of investors either buy or sell securities. We analyze the dynamics of asset prices in an economy with infrequent traders and price barriers. Our analysis predicts that when price barriers exist, both asset prices and price volatility can jump at the time the price barrier is reached, even if the trade is rationally anticipated. Moreover, the direction of the price jump may very well be the opposite of what one would expect. A price-triggered purchase may generate a downward jump in stock prices and, vice versa, a price-triggered sale may induce stock prices to jump above the price barrier. This is because trades affect prices before they are implemented: the anticipation of a stock purchase inflates stock prices, while the anticipation of a stock sale depresses stock prices. In the case of repeated trades, before-trade prices anticipate not only the next trade, but also the following ones. This may lead to the counterintuitive result that stock prices are inflated, rather than depressed, in the proximity of a stock sale.

JEL Classification: G12

working papers series