Valuation in Over-the-Counter Markets
39 Pages Posted: 12 Nov 2008
Date Written: March 2004
We provide the impact on asset prices of search-and-bargaining frictions in over-the-counter markets. Under natural conditions, prices are lower and illiquidity discounts higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners is smaller, or when risk aversion, volatility, or hedging demand are larger. If agents face risk limits, then higher volatility leads to greater difficulty locating unconstrained buyers, resulting in lower prices. Information can fail to be revealed through trading when search is difficult. We discuss a variety of financial applications and testable implications.
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