A Competitive Search Theory of Asset Pricing
75 Pages Posted: 7 Dec 2020 Last revised: 30 Apr 2021
Date Written: November 15, 2020
We develop an asset-pricing model with heterogeneous investors and search frictions. Trade is intermediated by risk-neutral dealers subject to capacity constraints. Risk-averse investors can direct their search towards dealers based on price and execution speed. Order flows affect the risk premium, volatility, and equilibrium interest rate. We propose a new solution method to characterize the equilibrium analytically. We assess the quantitative implications of the model in response to a large adverse shock. Consistent with the empirical evidence from the COVID-19 crisis, we find an increase in the risk premium and market illiquidity, and a decline in interest rates.
Keywords: Asset pricing, competitive search, market liquidity, perturbation techniques
JEL Classification: G11, G12, D53
Suggested Citation: Suggested Citation