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Search Frictions and Asset Price Volatility

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  • 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. 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.
  2. 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.
  3. Marsh, Terry A & Merton, Robert C, 1986. "Dividend Variability and Variance Bounds Tests for the Rationality ofStock Market Prices," American Economic Review, American Economic Association, vol. 76(3), pages 483-98, June.
  4. Kenneth D. West, 1986. "Dividend Innovations and Stock Price Volatility," NBER Working Papers 1833, National Bureau of Economic Research, Inc.
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  7. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  8. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  9. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
  10. 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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  15. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  16. 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.
  17. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  18. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, December.
  19. den Haan, Wouter J & Marcet, Albert, 1990. "Solving the Stochastic Growth Model by Parameterizing Expectations," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 31-34, January.
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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. Guillaume Rocheteau & Randall Wright, 2010. "Liquidity and asset market dynamics," Working Paper 1016, Federal Reserve Bank of Cleveland.
  2. Jacquet, Nicolas L. & Tan, Serene, 2012. "Money and asset prices with uninsurable risks," Journal of Monetary Economics, Elsevier, vol. 59(8), pages 784-797.
  3. Stephen D. Williamson & Randall Wright, 2010. "New Monetarist Economics: models," Staff Report 443, Federal Reserve Bank of Minneapolis.
  4. Stephen D. Williamson & Randall Wright, 2010. "New Monetarist Economics: methods," Staff Report 442, Federal Reserve Bank of Minneapolis.
  5. David M. Arseneau & Sanjay K. Chugh, 2008. "Optimal fiscal and monetary policy in customer markets," International Finance Discussion Papers 919, Board of Governors of the Federal Reserve System (U.S.).
  6. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
  7. Rocheteau, Guillaume, 2011. "Payments and liquidity under adverse selection," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 191-205.
  8. 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.

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