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Search Frictions and Asset Price Volatility

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Author Info

  • B. Ravikumar
  • Enchuan Shao

Abstract

We examine the quantitative effect of search frictions in product markets on asset price volatility. We combine several features from Shi (1997) and Lagos and Wright (2002) in a model without money. Households prefer special goods and general goods. Special goods can be obtained only via a search in decentralized markets. General goods can be obtained via trade in centralized competitive markets and via ownership of an asset. There is only one asset in our model that yields general goods. The asset is also used as a medium of exchange in the decentralized market to obtain the special goods. The value of the asset in facilitating transactions in the decentralized market is determined endogenously. This transaction role makes the asset pricing implications of our model different from those in the standard asset pricing model. Our model not only delivers the observed average rate of return on equity and the volatility of the equity price, but also accounts for most of the spectral characteristics of the equity price.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 10-1.

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Length: 25 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:bca:bocawp:10-1

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Keywords: Financial markets; Market structure and pricing;

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  1. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2004. "Over-the-Counter Markets," NBER Working Papers 10816, National Bureau of Economic Research, Inc.
  2. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  3. Lagos, Ricardo, 2010. "Asset prices and liquidity in an exchange economy," Journal of Monetary Economics, Elsevier, vol. 57(8), pages 913-930, November.
  4. LeRoy, Stephen F & LaCivita, C J, 1981. "Risk Aversion and the Dispersion of Asset Prices," The Journal of Business, University of Chicago Press, vol. 54(4), pages 535-47, October.
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  7. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
  8. Dmitrios Vayanos, 2004. "Search and Endogenous Concentration of Liquidity in Asset Markets," Econometric Society 2004 North American Winter Meetings 647, Econometric Society.
  9. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
  10. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  11. Ingram, Beth Fisher, 1990. "Equilibrium Modeling of Asset Prices: Rationality versus Rules of Thumb," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 115-25, January.
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  18. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December.
  19. Kleidon, Allan W, 1986. "Variance Bounds Tests and Stock Price Valuation Models," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 953-1001, October.
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  22. Michener, Ronald W, 1982. "Variance Bounds in a Simple Model of Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 166-75, February.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Search Frictions and Asset Price Volatility
    by Christian Zimmermann in NEP-DGE blog on 2010-01-18 05:02:28
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
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Cited by:
  1. Sanjay K. Chugh & David M. Arseneau, 2008. "Optimal Fiscal and Monetary Policy in Customer Markets," 2008 Meeting Papers 101, Society for Economic Dynamics.
  2. Stephen D. Williamson & Randall Wright, 2010. "New Monetarist Economics: methods," Staff Report 442, Federal Reserve Bank of Minneapolis.
  3. Randall Wright & Guillaume Rocheteau, 2011. "Liquidity and Asset Market Dynamics," 2011 Meeting Papers 103, Society for Economic Dynamics.
  4. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
  5. Jacquet, Nicolas L. & Tan, Serene, 2012. "Money and asset prices with uninsurable risks," Journal of Monetary Economics, Elsevier, vol. 59(8), pages 784-797.
  6. Rocheteau, Guillaume, 2011. "Payments and liquidity under adverse selection," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 191-205.
  7. Ricardo Lagos, 2011. "Asset Prices, Liquidity, and Monetary Policy in an Exchange Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 521-552, October.
  8. Stephen D. Williamson & Randall Wright, 2010. "New Monetarist Economics: models," Staff Report 443, Federal Reserve Bank of Minneapolis.

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