Search in Asset Markets

54 Pages Posted: 17 Oct 2007

See all articles by Ricardo Lagos

Ricardo Lagos

New York University (NYU) - Department of Economics

Guillaume Rocheteau

Federal Reserve Bank of Cleveland; National University of Singapore (NUS)

Date Written: July 2006

Abstract

We investigate how trading frictions in asset markets affect portfolio choices, asset prices and efficiency. We generalize the search-theoretic model of financial intermediation of Duffie, Gârleanu and Pedersen (2005) to allow for more general preferences and idiosyncratic shock structure, unrestricted portfolio choices, aggregate uncertainty and entry of dealers. With a fixed measure of dealers, we show that a steady-state equilibrium exists and is unique, and provide a condition on preferences under which a reduction in trading frictions leads to an increase in the price of the asset. We also analyze the effects of trading frictions on bid-ask spreads, trade volume and the volatility of asset prices, and find that the asset allocation is constrained-inefficient unless investors have all the bargaining power in bilateral negotiations with dealers. We show that the dealers' entry decision introduces a feedback that can give rise to multiple equilibria, and that free-entry equilibria are generically inefficient.

Keywords: asset prices, bid-ask spread, execution delay, liquidity, search, trade volume

JEL Classification: G11, G12, G21

Suggested Citation

Lagos, Ricardo and Rocheteau, Guillaume, Search in Asset Markets (July 2006). FRB of Cleveland Working Paper No. 06-07. Available at SSRN: https://ssrn.com/abstract=1022340 or http://dx.doi.org/10.2139/ssrn.1022340

Ricardo Lagos

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States
212-998-8937 (Phone)

Guillaume Rocheteau (Contact Author)

Federal Reserve Bank of Cleveland ( email )

PO Box 6387
Cleveland, OH 44101-1387
United States

National University of Singapore (NUS) ( email )

Bukit Timah Road 469 G
Singapore, 117591
Singapore

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