Search in asset markets

Ricardo Lagos and Guillaume Rocheteau

No 607, Working Papers (Old Series) from Federal Reserve Bank of Cleveland

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, Grleanu 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 pricing; Portfolio management (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-cfn, nep-dge, nep-fin, nep-fmk and nep-mst
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Citations: View citations in EconPapers (6)

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Working Paper: Search in asset markets (2006)
Working Paper: Search in Asset Markets (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedcwp:0607

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DOI: 10.26509/frbc-wp-200607

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