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Search and Endogenous Concentration of Liquidity in Asset Markets

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  • Dmitrios Vayanos

Abstract

In this paper, we develop a search-based model of asset trading. We assume that investors differ in their horizons, and can invest in two identical assets. The asset markets are partially segmented: investors can search in only one market, but can decide which one. We show that there exist a continuum of symmetric equilibria where investors are indifferent between the two markets, and a unique clientele equilibrium where short-horizon investors strictly prefer one market. This ``liquid" market has higher volume and prices, and lower search times for buyers and sellers. The clientele equilibrium generally dominates the symmetric ones, i.e., the concentration of liquidity is socially desirable. In some cases, however, the clientele equilibrium is dominated, and in these cases the entry of buyers in the liquid market is below the socially optimal level.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 647.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nawm04:647

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Keywords: search; liquidity premia; welfare;

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References

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  8. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
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  14. Dimitri Vayanos, 1998. "Transaction costs and asset prices : a dynamic equilibrium model," LSE Research Online Documents on Economics 451, London School of Economics and Political Science, LSE Library.
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  17. Diamond, Peter A, 1982. "Wage Determination and Efficiency in Search Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 49(2), pages 217-27, April.
  18. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 3-40.
  19. Ho, Thomas S Y & Stoll, Hans R, 1983. " The Dynamics of Dealer Markets under Competition," Journal of Finance, American Finance Association, vol. 38(4), pages 1053-74, September.
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  23. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
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