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Liquidity and congestion

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  • Afonso, Gara

Abstract

This paper studies the relationship between the endogenous arrival of investors to a market and liquidity in a search-based model of asset trading. Entry of investors causes two contradictory effects. First, it reduces trading costs, which attracts new investors (externality effect). But secondly, as investors concentrate on one side of the market, the market becomes "congested," decreasing the returns to investing and discouraging new investors from entering (congestion effect). The equilibrium level of liquidity depends on which of the two effects dominates. When congestion is the leading effect, some interesting results arise. In particular, diminishing trading costs can deteriorate liquidity and welfare.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Intermediation.

Volume (Year): 20 (2011)
Issue (Month): 3 (July)
Pages: 324-360

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Handle: RePEc:eee:jfinin:v:20:y:2011:i:3:p:324-360

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Web page: http://www.elsevier.com/locate/inca/622875

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Keywords: Liquidity Search Congestion Asset pricing;

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Citations

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Cited by:
  1. Guillaume Rocheteau & Pierre-Olivier Weill, 2011. "Liquidity in frictional asset markets," Working Paper 1105, Federal Reserve Bank of Cleveland.
  2. Atkeson, Andrew & Eisfeldt, Andrea L. & Weill, Pierre-Olivier, 2013. "The Market for OTC Derivatives," CEPR Discussion Papers 9403, C.E.P.R. Discussion Papers.
  3. Bruno Biais & Pierre-Olivier Weill, 2009. "Liquidity Shocks and Order Book Dynamics," NBER Working Papers 15009, National Bureau of Economic Research, Inc.
  4. Max Bruche & Anatoli Segura, 2013. "Debt Maturity And The Liquidity Of Secondary Debt Markets," Working Papers wp2013_1303, CEMFI.
  5. Gara Afonso & Anna Kovner & Antoinette Schoar, 2013. "Trading partners in the interbank lending market," Staff Reports 620, Federal Reserve Bank of New York.
  6. Selcuk, Cemil, 2012. "Distressed sales and liquidity in OTC markets," MPRA Paper 38188, University Library of Munich, Germany.
  7. Lagoarde-Segot, Thomas, 2013. "Does stock market development always improve firm-level financing? Evidence from Tunisia," Research in International Business and Finance, Elsevier, vol. 27(1), pages 183-208.
  8. Gara Afonso & Ricardo Lagos, 2012. "Trade dynamics in the market for federal funds," Staff Reports 549, Federal Reserve Bank of New York.
  9. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2009. "Crises and Liquidity in Over-the-Counter Markets," NBER Working Papers 15414, National Bureau of Economic Research, Inc.
  10. Makoto Watanabe, 2012. "Middlemen: A Directed Search Equilibrium Approach," Tinbergen Institute Discussion Papers 12-138/V, Tinbergen Institute.
  11. Patrick Bolton & Tano Santos & Jose A. Scheinkman, 2011. "Cream Skimming in Financial Markets," NBER Working Papers 16804, National Bureau of Economic Research, Inc.

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