RFS Advance Access originally published online on August 27, 2007
Review of Financial Studies 2007 20(6):1865-1900; doi:10.1093/rfs/hhm037
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Valuation in Over-the-Counter Markets
Graduate School of Business, Stanford University
University of California, Berkeley
Stern School of Business, New York University
Address correspondence to Darrell Duffie, Graduate School of Business, Stanford University, Stanford, CA 94305-5015, USA, or e-mail: duffie{at}stanford.edu
JEL: G1, G12, G14, D83, D4, D52
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Abstract |
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We provide the impact on asset prices of search-and-bargaining frictions in over-the-counter markets. Under certain conditions, illiquidity discounts are 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 is larger. Supply shocks cause prices to jump, and then "recover" over time, with a time signature that is exaggerated by search frictions: The price jump is larger and the recovery is slower in less liquid markets. We discuss a variety of empirical implications.
This paper includes work previously distributed under the title "Valuation in Dynamic Bargaining Markets." We are grateful for an insightful comment of Romans Pancs, for conversations with Yakov Amihud, Helmut Bester, Joseph Langsam, Richard Lyons, Tano Santos, and Jeff Zwiebel, and to participants at the NBER Asset Pricing Meeting, the Cowles Foundation Incomplete Markets and Strategic Games Conference, Hitotsubashi University, The London School of Economics, The University of Pennsylania, the Western Finance Association conference, the CEPR meeting at Gerzensee, University College London, The University of California, Berkeley, Université Libre de Bruxelles, Tel Aviv University, Yale University, and Universitat Autonoma de Barcelona. We also thank Gustavo Manso for research assistance, as well as the editor and referees for helpful suggestions.