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Limited Market Participation and Volatility of Asset Prices

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  • Allen, F.
  • Gale, D.

Abstract

Traditional asset-pricing theories assume complete market participation, despite considerable empirical evidence that most investors participate in a limited number of markets. The authors show that once the participation decision is endogenized, market properties change dramatically. First, limited market participation can amplify the effect of liquidity trading relative to full participation; under certain circumstances, an arbitrarily small aggregate liquidity shock can cause significant price volatility. Second, there exist multiple equilibria with very different participation regimes and levels of asset-price volatility. Third, under plausible conditions the equilibria can be Pareto-ranked; the Pareto-preferred equilibrium is characterized by greater participation and lower volatility. Copyright 1994 by American Economic Association.

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Bibliographic Info

Paper provided by Wharton School - Weiss Center for International Financial Research in its series Weiss Center Working Papers with number 2-92.

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Length: 6342 pages
Date of creation: 1991
Date of revision:
Handle: RePEc:fth:pennif:2-92

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Keywords: investments ; economic theory ; uncertainty ; economic equilibrium;

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