Intermediaries, Inventories And  Endogenous Dynamics  In Frictional Markets

Abstract

We study dynamics in frictional markets with inventories, focusing on models with intermediated trade, where middlemen buy assets or goods from sellers and sell them to buyers. Extending previous work, we include heterogeneous buyer valuations, and develop a characterization of equilibrium in terms of reservation trading strategies (homogeneous valuations imply bang-bang solutions with discontinuities that are awkward for the economics and mathematics). In continuous or discrete time, equilibria exist where market participation, trading strategies, liquidity, and other variables fluctuate as self-fulfilling prophecies. This is driven by strategic considerations, not increasing returns or related assumptions made in other models.

Keywords: Inventories, Intermediaries, Dynamics, Search