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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.

Suggested Citation

  • Chris Edmond & Pierre-Olivier Weill, 2011. "Aggregate Implications of Micro Asset Market Segmentation," Department of Economics - Working Papers Series 1117, The University of Melbourne.
  • Handle: RePEc:mlb:wpaper:1117
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    Cited by:

    1. Edmond, Chris & Weill, Pierre-Olivier, 2012. "Aggregate implications of micro asset market segmentation," Journal of Monetary Economics, Elsevier, vol. 59(4), pages 319-335.
    2. Fernando Alvarez & Francesco Lippi, 2014. "Persistent Liquidity Effects and Long-Run Money Demand," American Economic Journal: Macroeconomics, American Economic Association, vol. 6(2), pages 71-107, April.
    3. Zhiguo He & Arvind Krishnamurthy, 2013. "Intermediary Asset Pricing," American Economic Review, American Economic Association, vol. 103(2), pages 732-770, April.

    More about this item

    Keywords

    Asset pricing; market segmentation; idiosyncratic risk;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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