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The role of trading frictions in financial markets

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  • Samuel Huber
  • Jaehong Kim

Abstract

We develop a dynamic general equilibrium model to analyze the role of trading frictions in over-the-counter financial markets. In our model, agents face idiosyncratic preference shocks and a financial market allows them to rebalance their portfolio composed of liquid and illiquid assets in response to these shocks. We disentangle the effects of search and bargaining on welfare and study each one of them. We show that bargaining is welfare-improving for any inflation rate above the Friedman rule, while search frictions are not. This is because search frictions do not only affect the demand for the respective assets, but also their allocation.

Suggested Citation

  • Samuel Huber & Jaehong Kim, 2015. "The role of trading frictions in financial markets," ECON - Working Papers 211, Department of Economics - University of Zurich, revised Jul 2017.
  • Handle: RePEc:zur:econwp:211
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    Cited by:

    1. Huber, Samuel & Kim, Jaehong, 2019. "The role of trading frictions in financial markets," Journal of Economic Dynamics and Control, Elsevier, vol. 99(C), pages 1-18.
    2. Huber, Samuel & Kim, Jaehong, 2020. "An overlapping generations model for monetary policy analysis," European Economic Review, Elsevier, vol. 125(C).
    3. Huber, Samuel & Kim, Jaehong, 2017. "On the optimal quantity of liquid bonds," Journal of Economic Dynamics and Control, Elsevier, vol. 79(C), pages 184-200.
    4. Constantin ANGHELACHE & Emilia STANCIU & Marius POPOVIC & Alexandru URSACHE, 2016. "Aspects regarding macro-prudential Instruments ensuring financial stability," Romanian Statistical Review Supplement, Romanian Statistical Review, vol. 64(5), pages 83-85, May.
    5. Zannini, Ugo, 2020. "The optimal quantity of money and partially-liquid assets," Journal of Economic Theory, Elsevier, vol. 188(C).

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    More about this item

    Keywords

    Monetary theory; over-the-counter markets; financial regulation; corporate bonds; liquidity;
    All these keywords.

    JEL classification:

    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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