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Income dispersion, asymmetric information and fluctuations in market efficiency

  • Chris Edmond

    ()

    (Economics, Stern School of Business New York University)

  • Laura Veldkamp

Recessions appear to be times when markets function less efficiently. This phenomenon has been the domain of theories that rely on changes in preferences (demand shocks) or constraints on price-setting (sticky prices). In our simple model of decentralized trade with asymmetric information, income dispersion measures uncertainty about buyer characteristics. Counter-cyclical income dispersion makes the asymmetric information friction stronger in recessions: optimal prices rise and trade volume falls. Unlike preference changes or price-setting constraints, income dispersion is observable. Using income dispersion estimates to quantify the model's effect, we find that model prices, sales and markups have properties similar to business cycle data.

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 717.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:717
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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