Heterogeneity in Decentralized Asset Markets∗

We consider a decentralized market for an asset (or durable good) where investors’ valuations are heterogeneous and drawn from an arbitrary distribution. We provide a full characterization of the equilibrium, in closed form, both in and out of steady state. We find that investors with moderate valuations tend to specialize in intermediation, so that a “core-periphery” trading network emerges endogenously. This has important implications for both individual trading patterns–such as the expected amount of time it takes for each type of investor to trade–as well as aggregate outcomes–such as the degree of misallocation in the economy, the total volume of trade, and the amount of price dispersion. We also characterize the equilibrium in the limiting economy as trading frictions vanish. We show that price dispersion vanishes relatively quickly, price levels converge to their frictionless counterpart relatively slowly, and trading volume does not converge at all; that is, in the limit, the volume of trade is infinite. PRELIMINARY AND INCOMPLETE: PLEASE DO NOT CIRCULATE ∗We thank ... The views expressed here are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System. †Swiss Finance Institute and Ecole Polytechnique Fédérale de Lausanne. ‡Federal Reserve Bank of Philadelphia. §UCLA and NBER.