Tsunami, PRELIMINARY

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 analyzed. I demonstrate that transition paths of liquidity toward 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 to 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.