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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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References

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  8. Dimitri Vayanos & Jean-Luc Vila, 1999. "Equilibrium interest rate and liquidity premium with transaction costs," LSE Research Online Documents on Economics 453, London School of Economics and Political Science, LSE Library.
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  17. Pagano, Marco, 1986. "Trading Volume and Asset Liquidity," CEPR Discussion Papers 142, C.E.P.R. Discussion Papers.
  18. Warga, Arthur, 1992. "Bond Returns, Liquidity, and Missing Data," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(04), pages 605-617, December.
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  20. Constantinides, George M, 1986. "Capital Market Equilibrium with Transaction Costs," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 842-62, August.
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