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Search Frictions and Asset Price Volatility

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  • B. Ravikumar
  • Enchuan Shao

Abstract

We examine the quantitative effect of search frictions in product markets on asset price volatility. We combine several features from Shi (1997) and Lagos and Wright (2002) in a model without money. Households prefer special goods and general goods. Special goods can be obtained only via a search in decentralized markets. General goods can be obtained via trade in centralized competitive markets and via ownership of an asset. There is only one asset in our model that yields general goods. The asset is also used as a medium of exchange in the decentralized market to obtain the special goods. The value of the asset in facilitating transactions in the decentralized market is determined endogenously. This transaction role makes the asset pricing implications of our model different from those in the standard asset pricing model. Our model not only delivers the observed average rate of return on equity and the volatility of the equity price, but also accounts for most of the spectral characteristics of the equity price.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2005 Meeting Papers with number 227.

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Date of creation: 2005
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Handle: RePEc:red:sed005:227

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Keywords: Excess volatility; liquidity;

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References

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  1. S. Rao Aiyagari, 1993. "Explaining financial market facts: the importance of incomplete markets and transaction costs," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 17-31.
  2. DeJong, David N & Whiteman, Charles H, 1991. "The Temporal Stability of Dividends and Stock Prices: Evidence from the Likelihood Function," American Economic Review, American Economic Association, vol. 81(3), pages 600-617, June.
  3. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
  4. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December.
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  7. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, vol. 49(3), pages 555-74, May.
  8. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  9. Pierre-Olivier Weill, 2004. "Liquidity Premia in Dynamic Bargaining Markets," Econometric Society 2004 North American Winter Meetings 648, Econometric Society.
  10. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
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  14. Ricardo Lagos, 2005. "Asset Prices and Liquidity in an Exchange Economy," 2005 Meeting Papers 143, Society for Economic Dynamics.
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  17. LeRoy, Stephen F & LaCivita, C J, 1981. "Risk Aversion and the Dispersion of Asset Prices," The Journal of Business, University of Chicago Press, vol. 54(4), pages 535-47, October.
  18. Marsh, Terry A & Merton, Robert C, 1986. "Dividend Variability and Variance Bounds Tests for the Rationality ofStock Market Prices," American Economic Review, American Economic Association, vol. 76(3), pages 483-98, June.
  19. Robert J. Shiller, 1984. "Stock Prices and Social Dynamics," Cowles Foundation Discussion Papers 719R, Cowles Foundation for Research in Economics, Yale University.
  20. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, January.
  21. Dmitrios Vayanos, 2004. "Search and Endogenous Concentration of Liquidity in Asset Markets," Econometric Society 2004 North American Winter Meetings 647, Econometric Society.
  22. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  23. Ingram, Beth Fisher, 1990. "Equilibrium Modeling of Asset Prices: Rationality versus Rules of Thumb," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 115-25, January.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Search Frictions and Asset Price Volatility
    by Christian Zimmermann in NEP-DGE blog on 2010-01-18 05:02:28
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Cited by:
  1. Rocheteau, Guillaume & Wright, Randall, 2013. "Liquidity and asset-market dynamics," Journal of Monetary Economics, Elsevier, vol. 60(2), pages 275-294.
  2. Jacquet, Nicolas L. & Tan, Serene, 2012. "Money and asset prices with uninsurable risks," Journal of Monetary Economics, Elsevier, vol. 59(8), pages 784-797.
  3. Stephen D. Williamson & Randall Wright, 2010. "New Monetarist Economics: models," Staff Report 443, Federal Reserve Bank of Minneapolis.
  4. Ricardo Lagos, 2005. "Asset Prices and Liquidity in an Exchange Economy," 2005 Meeting Papers 143, Society for Economic Dynamics.
  5. Rocheteau, Guillaume, 2011. "Payments and liquidity under adverse selection," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 191-205.
  6. Ricardo Lagos, 2009. "Asset Prices, Liquidity, and Monetary Policy in an Exchange Economy," 2009 Meeting Papers 390, Society for Economic Dynamics.
  7. Stephen Williamson & Randall Wright, 2010. "New monetarist economics: methods," Review, Federal Reserve Bank of St. Louis, issue May, pages 265-302.

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