Endogenous Market Thinness and Stock Price Volatility

Marco Pagano

No 146, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Thin equity markets cannot accommodate temporary bulges of buy or sell orders without large price movements: the resulting volatility can induce risk-averse transactors who face transaction costs to desert these markets altogether. Thus thinness and the consequent price volatility may become joint self-perpetuating features of an equity market, whatever the volatility of asset fundamentals. If, however, appropriate incentive schemes are adopted to encourage entry of additional investors, this vicious circle can be broken, eventually shifting the market to a self-sustaining, superior equilibrium, characterized by a higher number of transactors, lower price volatility and larger supply of the asset.

Keywords: Stock Market; Stock Prices; Thin Financial Markets; Transaction Costs; Volatility (search for similar items in EconPapers)
Date: 1986-12
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Journal Article: Endogenous Market Thinness and Stock Price Volatility (1989)
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