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Heterogeneity in Decentralized Asset Markets

Author

Listed:
  • Julien HUGONNIER

    (Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute)

  • Benjamin LESTER

    (Federal Reserve Bank of Philadelphia)

  • Pierre-Olivier WEILL

    (University of California, Los Angeles and NBER)

Abstract

We study a search and bargaining model of an asset market, where investors’ heterogeneous valuations for the asset are drawn from an arbitrary distribution. Our solution technique renders the analysis fully tractable and allows us to provide a full characterization of the equilibrium, in closed form, both in and out of steady state. We use this characterization for two purposes. First, we establish that the model can naturally account for a number of stylized facts that have been documented in empirical studies of over-the-counter asset markets. In particular, we show that heterogeneity among market participants implies that assets are reallocated through “intermediation chains,” ultimately producing a core-periphery trading network and non-trivial distributions of prices and trading times. Second, we show that the model generates a number of novel results that underscore the importance of heterogeneity in decentralized markets. We highlight two: first, heterogeneity magnifies the price impact of search frictions; and second, search frictions have larger effects on price levels than on price dispersion. Hence, quantifying the price discount or premium created by search frictions based on observed price dispersion can be misleading.

Suggested Citation

  • Julien HUGONNIER & Benjamin LESTER & Pierre-Olivier WEILL, 2014. "Heterogeneity in Decentralized Asset Markets," Swiss Finance Institute Research Paper Series 14-67, Swiss Finance Institute.
  • Handle: RePEc:chf:rpseri:rp1467
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Robert Shimer & Gregor Jarosch & Maryam Farboodi, 2016. "Meeting Technologies in Decentralized Asset Markets," 2016 Meeting Papers 844, Society for Economic Dynamics.
    2. Taneli Mäkinen & Francesco Palazzo, 2017. "The double bind of asymmetric information in over-the-counter markets," Temi di discussione (Economic working papers) 1128, Bank of Italy, Economic Research and International Relations Area.
    3. Chang, Briana & Zhang, Shengxing, 2015. "Endogenous market making and network formation," LSE Research Online Documents on Economics 86275, London School of Economics and Political Science, LSE Library.
    4. Zhang, Shengxing, 2018. "Liquidity misallocation in an over-the-counter market," LSE Research Online Documents on Economics 86800, London School of Economics and Political Science, LSE Library.
    5. Anton Tsoy, 2016. "Liquidity and Prices in Decentralized Markets with Almost Public Information," 2016 Meeting Papers 8, Society for Economic Dynamics.
    6. Chang, Briana & Zhang, Shengxing, 2015. "Endogenous market making and network formation," LSE Research Online Documents on Economics 65105, London School of Economics and Political Science, LSE Library.
    7. repec:eee:jetheo:v:173:y:2018:i:c:p:231-256 is not listed on IDEAS
    8. Maryam Farboodi & Gregor Jarosch & Guido Menzio, 2016. "Intermediation as Rent Extraction," PIER Working Paper Archive 16-026, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 01 Dec 2016.
    9. Zhang, Shengxing, 2018. "Liquidity misallocation in an over-the-counter market," Journal of Economic Theory, Elsevier, vol. 174(C), pages 16-56.
    10. Jerome Dugast & Pierre-Olivier Weill & Semih Uslu, 2018. "Platform Trading with an OTC Market Fringe," 2018 Meeting Papers 1002, Society for Economic Dynamics.
    11. Marco Di Maggio & Amir Kermani & Zhaogang Song, 2016. "The Value of Trading Relationships in Turbulent Times," NBER Working Papers 22332, National Bureau of Economic Research, Inc.
    12. Derek G. Stacey, 2015. "Posted Prices, Search and Bargaining," Working Papers 059, Ryerson University, Department of Economics, revised Nov 2018.
    13. Friewald, Nils & Nagler, Florian, 2018. "Over-the-Counter Market Frictions and Yield Spread Changes," CEPR Discussion Papers 13345, C.E.P.R. Discussion Papers.
    14. repec:fip:fedreq:00061 is not listed on IDEAS
    15. repec:aea:aecrev:v:107:y:2017:i:11:p:3320-62 is not listed on IDEAS
    16. Babus, Ana & Hu, Tai-Wei, 2017. "Endogenous intermediation in over-the-counter markets," Journal of Financial Economics, Elsevier, vol. 125(1), pages 200-215.
    17. Frei, Christoph & Capponi, Agostino & Brunetti, Celso, 2017. "Managing Counterparty Risk in OTC Markets," Finance and Economics Discussion Series 2017-083, Board of Governors of the Federal Reserve System (US), revised 25 Oct 2018.
    18. Maryam Farboodi & Gregor Jarosch & Robert Shimer, 2017. "The Emergence of Market Structure," NBER Working Papers 23234, National Bureau of Economic Research, Inc.
    19. Trejos, Alberto & Wright, Randall, 2016. "Search-based models of money and finance: An integrated approach," Journal of Economic Theory, Elsevier, vol. 164(C), pages 10-31.
    20. repec:eee:jfinec:v:124:y:2017:i:2:p:266-284 is not listed on IDEAS
    21. Shengxing Zhang & Briana Chang, 2015. "Endogenous Market-making and Formation of Trading Links," 2015 Meeting Papers 1227, Society for Economic Dynamics.
    22. Shen, Ji & Wei, Bin & Yan, Hongjun, 2016. "Financial Intermediation Chains in an OTC Market," MPRA Paper 74925, University Library of Munich, Germany.
    23. Kurmann, André & Rabinovich, Stanislav, 2018. "Dynamic inefficiency in decentralized capital markets," Journal of Economic Theory, Elsevier, vol. 173(C), pages 231-256.

    More about this item

    Keywords

    Search frictions; bargaining; continuum of types; price dispersion;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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