Tsunami: Market Tightness and Asset Price Volatility

Research output: Contribution to journalArticle

Abstract

This paper considers an asset market subject to search frictions, where there are adjustment costs to the entry rate of buyers. An implication is that even in asset markets where the search frictions are very small, asset prices respond to changes in liquidity. Another implication is that asset liquidity is a state variable, the dynamics of which are analysed. I demonstrate that transition paths of liquidity to its (stable) steady state can exhibit dramatic divergence before convergence following small positive deviations in the measure of buyers in the market. Thus, adjustment costs of entry are a potential source of volatility by generating large waves of liquidity, or “tsunami”, in asset markets. I quantitatively assess the ability of the mechanism to generate asset market booms and busts via the implied price movements.

Original languageEnglish
Pages (from-to)355-380
Number of pages26
JournalGlobal Economic Review
Volume43
Issue number4
DOIs
Publication statusPublished - 2014 Oct 2

All Science Journal Classification (ASJC) codes

  • Business and International Management
  • Economics, Econometrics and Finance(all)
  • Political Science and International Relations

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