We provide the impact on asset prices of search-and-bargaining frictions in over-the-counter markets. Under natural conditions, prices are lower and illiquidity discounts higher when counterparties are harder to find, when sellers have less bargaining power, when the fraction of qualified owners is smaller, or when risk aversion, volatility, or hedging demand are larger. If agents face risk lim...

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 sho...

It is known that the incompleteness of asset markets causes inefficiency in almost every equilibrium. Yet unexplored is the ”size” of this inefficiency. The size of a Pareto improvement is the total willingness to pay for it, out of current consumption. Inefficiency is the maximum size of any Pareto improving reallocation. Inefficiency of US consumption in middle age is computed to be 10-11% of...

This paper shows that consumption-based asset pricing theory imposes no testable restrictions on either macroeconomic or cross-sectional data if one allows for uninsurable idiosyncratic income shocks which are persistent and not normally distributed. More precisely, this paper shows that any “observed” joint process of arbitrage-free asset prices and payoffs, aggregate consumption, and moments ...

This paper uses numerical dynamic stochastic programming methods to show that an insurance market can reduce the long-term extent and depth of poverty in a stylized, risk-prone rural region. This impact operates through both an ex post vulnerability reduction effect and an ex ante investment incentive effect. The result is not only lower poverty, but also substantial savings in public cash tran...

This paper presents an experiment which investigates whether asset prices are affected in markets where state probabilities are not exactly known and traders have to form subjective probabilities of payoffs. Results show that the presence of vague probabilities leads to higher average prices with respect to assets characterised by known probabilities. However, prices under known and vague proba...

We consider a three period economy where traders trade assets before and after the arrival of a signal (or data). We say that a trader has rationalizable beliefs if i) she is an SEU maximizer and if ii) her likelihood ratio of the data relative to various states of the world is equal to the objective likelihood ratio of the data (a restriction on her beliefs). A candidate equilibrium is an outc...

This paper determines the equilibrium ownership structure in an emerging market deregulated by privatization and investment liberalization. It is shown that bidding competition in the privatization stage is necessary but not sufficient for reaching an efficient equilibrium market structure. Competition in the ensuing entry stage is also necessary. Otherwise, one firm can induce another to take ...

We elicit traders' predictions of future price trajectories in repeated experimental markets for a 15-period-lived asset. We find that individuals' beliefs aboutprices are adaptive, and primarily based on past trends in the current and previous markets in which they have participated. Most traders do not anticipate market downturns the first time they participate in a market, and, when experien...

This paper studies the impact of ambiguity and ambiguity aversion on equilibrium asset prices and portfolio holdings in competitive financial markets. It argues that attitudes toward ambiguity are heterogeneous across the population, just as attitudes toward risk are heterogeneous across the population, but that heterogeneity of attitudes toward ambiguity has different implications than heterog...