Liquidity and selection in asset markets with search frictions

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Abstract

I construct a model of an asset market subject to search frictions, in an environment where both asset liquidity and market composition are determined endogenously. The analysis predicts that higher asset prices resulting from exogenously higher asset earnings imply: (i) a shorter search duration for sellers (higher liquidity), (ii) a shorter owner tenure before listing assets for resale (turnover), (iii) a higher stock of buyers, and (iv) a higher share of the asset stock traded (trade volume). Asset price-earnings ratios respond positively to earnings because liquidity premia respond to the size of earnings relative to the costs of search. I show that liquidity effects and selection effects reinforce each other in the presence of search frictions.

Original languageEnglish
Pages (from-to)113-142
Number of pages30
JournalJournal of Economic Theory and Econometrics
Volume23
Issue number2
Publication statusPublished - 2012 Jun

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

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