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Liquidity in Asset Markets with Search Frictions

Ricardo Lagos and Guillaume Rocheteau
Econometrica
Vol. 77, No. 2 (Mar., 2009), pp. 403-426
Published by: The Econometric Society
Stable URL: http://www.jstor.org/stable/40263870
Page Count: 24
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Since scans are not currently available to screen readers, please contact JSTOR User Support for access. We'll provide a PDF copy for your screen reader.
Liquidity in Asset Markets with Search Frictions
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Abstract

We develop a search-theoretic model of financial intermediation in an over-thecounter market and study how trading frictions affect the distribution of asset holdings 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 trade volume, bid-ask spreads, and trading delays—the dimensions of market liquidity that search-based theories seek to explain.

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