The role of trading frictions in financial markets
Samuel Huber, Jaehong Kim
Journal of Economic Dynamics and Control (2019) 99, 1–18
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We develop a dynamic general equilibrium model to analyze the role of trading frictions in over-the-counter markets. In our model, agents face idiosyncratic preference shocks and a financial market allows them to rebalance their portfolio composed of money and bonds in response to these shocks. We disentangle the effects of search and bargaining on welfare and study each one of them. We show that bargaining is generally welfare-improving, while search frictions are not. This is because search frictions do not only affect the demand for the respective assets, but also their allocation.
JEL-Codes: D47; D52; D62; E31; E44; E50; G11; G12
Keywords: Monetary theory, Over-the-counter markets, Search and bargaining