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Creator: Lagos, Ricardo and Rocheteau, Guillaume Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 408 Abstract:
We develop a search-theoretic model of financial intermediation and use it to study how trading frictions affect the distribution of asset holdings, asset prices, efficiency, and standard measures of liquidity. A distinctive feature of our theory is that it allows for unrestricted asset holdings, so market participants can accommodate trading frictions by adjusting their asset positions. We show that these individual responses of asset demands constitute a fundamental feature of illiquid markets: they are a key determinant of bid-ask spreads, trade volume, and trading delays—all the dimensions of market liquidity that search-based theories seek to explain.
This paper is an extension of Ricardo Lagos’s work while he was in the Research Department of the Federal Reserve Bank of Minneapolis.
Palavra-chave: Liquidity, Bid-ask spread, Trade volume, Execution delay, and Search Sujeito: D83 - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness and D10 - Household Behavior: General
Creator: Alvarez, Fernando, 1964- and Atkeson, Andrew Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 577 Abstract:
We develop a new general equilibrium model of asset pricing and asset trading volume in which agents’ motivations to trade arise due to uninsurable idiosyncratic shocks to agents’ risk tolerance. In response to these shocks, agents trade to rebalance their portfolios between risky and riskless assets. We study a positive question — When does trade volume become a pricing factor? — and a normative question — What is the impact of Tobin taxes on asset trading on welfare? In our model, economies in which marketwide risk tolerance is negatively correlated with trade volume have a higher risk premium for aggregate risk. Likewise, for a given economy, we ﬁnd that assets whose cash ﬂows are concentrated on states with high trading volume have higher prices and lower risk premia. We then show that Tobin taxes on asset trade have a ﬁrst-order negative impact on ex-ante welfare, i.e., a small subsidy to trade leads to an improvement in ex-ante welfare. Finally, we develop an alternative version of our model in which asset trade arises from uninsurable idiosyncratic shocks to agents’ hedging needs rather than shocks to their risk tolerance. We show that our positive results regarding the relationship between trade volume and asset prices carry through. In contrast, the normative implications of this speciﬁcation of our model for Tobin taxes or subsidies depend on the speciﬁcation of agents’ preferences and non-traded endowments.
Palavra-chave: Liquidity, Asset pricing, Trade volume, and Tobin taxes Sujeito: G12 - Asset Pricing; Trading Volume; Bond Interest Rates
Creator: Lagos, Ricardo and Rocheteau, Guillaume Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 375 Abstract:
We investigate how trading frictions in asset markets affect portfolio choices, asset prices and efficiency. We generalize the search-theoretic model of financial intermediation of Duffie, Gârleanu and Pedersen (2005) to allow for more general preferences and idiosyncratic shock structure, unrestricted portfolio choices, aggregate uncertainty and entry of dealers. With a fixed measure of dealers, we show that a steady-state equilibrium exists and is unique, and provide a condition on preferences under which a reduction in trading frictions leads to an increase in the price of the asset. We also analyze the effects of trading frictions on bid-ask spreads, trade volume and the volatility of asset prices, and find that the asset allocation is constrained-inefficient unless investors have all the bargaining power in bilateral negotiations with dealers. We show that the dealers’ entry decision introduces a feedback that can give rise to multiple equilibria, and that free-entry equilibria are generically inefficient.
Palavra-chave: Liquidity, Asset prices, Bid-ask spread, Trade volume, Execution delay, and Search Sujeito: G12 - Asset Pricing; Trading Volume; Bond Interest Rates, G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages, and G11 - Portfolio Choice; Investment Decisions