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Aggregate Implications of Micro Asset Market Segmentation

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  • Chris Edmond
  • Pierre-Olivier Weill

Abstract

This paper develops a consumption-based asset pricing model to explain and quantify the aggregate implications of a frictional financial system, comprised of many financial markets partially integrated with one another. Each of our micro financial market's is inhabited by traders who are specialized in that markets type of asset. We specify exogenously the level of segmentation that ultimately determines how much idiosyncratic risk traders bear in their micro market and derive aggregate asset pricing implications. We pick segmentation parameters to match facts about systematic and idiosyncratic return volatility. We find that if the same level of segmentation prevails in every market, traders bear 30% of their idiosyncratic risk. With otherwise standard parameters, this benchmark model delivers an unconditional equity premium of 2.4% annual. We further disaggregate the model by allowing the level of segmentation to differ across markets. This version of the model delivers the same aggregate asset pricing implications but with only one-third the amount of segmentation: on average traders bear 10% of their idiosyncratic risk.

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Bibliographic Info

Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 1117.

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Length: 43 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:mlb:wpaper:1117

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Keywords: Asset pricing; market segmentation; idiosyncratic risk;

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References

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Cited by:
  1. Alvarez, Fernando E & Lippi, Francesco, 2011. "Persistent Liquidity Effects and Long Run Money Demand," CEPR Discussion Papers 8650, C.E.P.R. Discussion Papers.
  2. Zhiguo He & Arvind Krishnamurthy, 2013. "Intermediary Asset Pricing," American Economic Review, American Economic Association, vol. 103(2), pages 732-70, April.

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