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Liquidity in asset markets with search frictions

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  • Ricardo Lagos
  • Guillaume Rocheteau

Abstract

We develop a search-theoretic model of financial intermediation and use it to study how trading frictions affect the distribution of asset holdings, asset prices, efficiency and standard measures of liquidity. A distinctive feature of our theory is that it allows for unrestricted asset holdings, so market participants can accommodate trading frictions by adjusting their asset positions. We show that these individual responses of asset demands constitute a fundamental feature of illiquid markets: they are a key determinant of bid-ask spreads, trade volume and trading delays?all the dimensions of market liquidity that search-based theories seek to explain.

Suggested Citation

  • Ricardo Lagos & Guillaume Rocheteau, 2008. "Liquidity in asset markets with search frictions," Working Papers (Old Series) 0804, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwp:0804
    DOI: 10.26509/frbc-wp-200804
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    Keywords

    Liquidity (Economics); Over-the-counter markets; Investments;
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