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Search and endogenous concentration of liquidity in asset markets

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  • Dimitri Vayanos
  • Tan Wang

Abstract

We develop a search-based model of asset trading, in which investors of different horizons can invest in two identical assets. The asset markets are partially segmented: buyers can search for only one asset, but can decide which one. We show that there exists a "clientele" equilibrium where one market has more buyers and sellers, lower search times, higher trading volume, higher prices, and short-horizon investors. This equilibrium dominates the ones where the two markets are identical, implying that the concentration of liquidity in one asset is socially desirable. At the same time, too many buyers decide to search for the liquid asset.

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File URL: http://eprints.lse.ac.uk/455/
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Bibliographic Info

Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 455.

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Length: 48 pages
Date of creation: Aug 2004
Date of revision:
Handle: RePEc:ehl:lserod:455

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Keywords: Liquidity; search; asset pricing JEL classification codes : G1; D8;

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  2. Lippman, Steven A & McCall, John J, 1986. "An Operational Measure of Liquidity," American Economic Review, American Economic Association, vol. 76(1), pages 43-55, March.
  3. Michael J. Fleming, 2002. "Are larger Treasury issues more liquid? Evidence from bill reopenings," Staff Reports 145, Federal Reserve Bank of New York.
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  8. Lawrence R. Glosten & Paul R. Milgrom, 1983. "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders," Discussion Papers 570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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  10. 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. Duffie, Darrell & Garleanu, Nicolae & Pedersen, Lasse Heje, 2002. "Securities lending, shorting, and pricing," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 307-339.
  18. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
  19. Diamond, Peter A, 1982. "Wage Determination and Efficiency in Search Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 49(2), pages 217-27, April.
  20. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  21. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, vol. 73(6), pages 1815-1847, November.
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