Thick-Market Effects in Real Asset Markets

Almost all real assets trade in decentralized markets, where trading frictions could inhibit the efficiency of asset allocations and depress asset prices. In this paper, I investigate how trading frictions vary as asset markets get thicker, and what implications market thickness has for asset allocations and prices. Intuitively, it is easier to sell assets that have a thicker market. As a result, firms find it optimal to hold on longer to assets with a thinner market in case their profitability rises in the future. Thus, firms’ average productivity is higher and productivity dispersion is lower when markets for firms’ assets are thicker. In turn, asset prices are on average higher and have a lower dispersion of transaction prices in thicker asset markets, since prices depend on firms’ profitabilities. I formalize this intuition in a model of trading in decentralized markets with twosided search and bilateral bargaining. I then use data on commercial aircraft markets to test the implications of the model. As predicted by the theory, the empirical analysis shows that aircraft with a thicker market have: 1) higher turnover; 2) higher capacity utilization; 3) lower dispersion of utilization levels; 4) higher mean prices; and 5) lower dispersion of transaction prices. School of Management and Cowles Foundation, Yale University, P.O. Box 208200, New Haven, CT 06520-8200. Email: [email protected]. A previous version of the paper was distributed under the title “Liquidity in Real Asset Markets”. I am grateful to Pierre-Olivier Weill and to my colleagues at Yale for comments and suggestions, to Todd Pulvino for providing some of the data used in this paper, and to Jessica Jiang, Alistair Wilson and Jihye Jeon for help with the research.