market friction Concepts

Matchmakers: The New Economics of Multisided Platforms

by David S. Evans and Richard Schmalensee · 23 May 2016 · 383pp · 81,118 words

, this important type of business didn’t have a name. That’s surprising, in retrospect. Many businesses had been built to reduce these sorts of market frictions, which economists tend to call transaction costs. Their basic business model had been around for thousands of years. But business schools didn’t teach classes

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help different parties get together to exchange value. Economists didn’t have a clue how these businesses worked. In fact, the companies that reduced these market frictions charged prices and adopted other strategies that economic textbooks insisted no sensible business would do. Now we call these businesses multisided platforms.2 Don’t

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from eliminating that friction can guide decisions on ignition strategies as well as on pricing. Sometimes, as with OpenTable, the platform drastically reduces a clear market friction, and the issue is whether the friction is big enough to enable the platform to earn adequate revenue to cover all the costs of launching

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in Kenya is a remarkable story of how a company figured out how to ignite a multisided platform in trying circumstances, to massively reduce important market frictions, and to provide financial services to millions of impoverished people. And it is a story of how multisided platforms—M-PESA and other mobile money

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined

by Lasse Heje Pedersen · 12 Apr 2015 · 504pp · 139,137 words

are prices and returns to their fully efficient values in an efficiently inefficient market? Well, because of competition, securities’ returns net of all the relevant market frictions—transaction costs, liquidity risk, and funding costs—are very close to their fully efficient levels in the sense that consistently beating the market is extremely

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bonds before maturity and dividend payments when they need to free up cash or face large short sale costs (defying Merton’s Rule). The financial market frictions influence the real economy, and unconventional monetary policy, such as central banks’ lending facility, can be important in addressing liquidity draughts.4 TABLE I.1

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inflation is best) and the rule of law. Also, supply shocks can arise from changes in labor-market frictions (sticky wages, search frictions, and rigid labor laws), product-market frictions (sticky prices and anticompetitive corporate measures), and capital-market frictions (market and funding illiquidity) leading to unemployment and lower capital utilization. For instance, a systemic banking

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trends based on initial underreaction to news and delayed overreaction as well as the extensive literature on behavioral biases, herding, central bank behavior, and capital market frictions. If prices initially underreact to news, then trends arise as prices slowly move to more fully reflect changes in fundamental value. These trends have the

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.1. Stylized plot of the life cycle of a trend. Source: Hurst, Ooi, and Pedersen (2013). Research has documented a number of behavioral tendencies and market frictions that lead to this initial underreaction:3 i. Anchor-and-insufficient-adjustment. People tend to anchor their views to historical data and adjust their views

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-factor model frictions: in arbitrage trading, 235; carry trading and, ix; demand pressures created by, 46; early conversion of bond and, 276; funding frictions, 7t; market frictions, 5; short sales and, 119–21; supply shocks arising from, 196; trend-following strategies and, 209, 211 front-running, 107 fundamental analysis, 41, 88, 97

Expected Returns: An Investor's Guide to Harvesting Market Rewards

by Antti Ilmanen · 4 Apr 2011 · 1,088pp · 228,743 words

and 2010, empirical and theoretical work added flesh to the core models by incorporating multiple risk factors, time-varying expected returns, liquidity effects and other market frictions, as well as investor irrationality. The field is increasingly seeking help from outside finance, economics, and statistics by turning to psychology, biology, physics, and even

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; • skewness and liquidity preferences (liking lottery tickets and liquid assets); • supply–demand effects on asset prices; and • market inefficiencies (due to investor irrationalities and/or market frictions). Behavioral finance and investor irrationalities will be discussed in the next chapter. In case you are a practitioner thinking that rational investor models are irrelevant

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several strands of literature. In the new thinking on expected returns, multiple systematic factors, time-varying risk premia, skewness and liquidity preferences, supply–demand effects, market frictions, and investor irrationalities can all play a role [4]. (No single model can capture all of these features. Theoretical models need to be analytically tractable

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may do the opposite. Arbitrage does mitigate the supply–demand effects on asset prices and expected returns (especially among stocks with close substitutes) but because market frictions exist and arbitrage is not riskless, it does not fully eliminate them. Supply effects—examples • Shorter run supply influences are especially notable for commodities that

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the liberalization of foreign capital flows is incomplete. The full integration of all countries into global markets is a hoped-for outcome, not a reality. Market frictions and illiquidity premia The impact of supply–demand factors—and of investor irrationalities—on asset prices is made possible by

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market frictions. Frictions related to illiquidity, funding constraints, and trading costs, as well as counterparty risk, agency concerns, and other information problems can be first-order important,

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risk aversion do not alone explain the distressed price levels of securitized bonds and other assets. Many financial intermediaries and investors became forced sellers as market frictions prevented them and other investors from taking advantage of good deals or nearly riskless arbitrage opportunities. Opportunities that appeared compelling over the long horizon could

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possibility that further de-levering and related mark-to-market volatility would make the investment positions unsustainable over the short run. A diverse literature on market frictions explains why asset prices might deviate from fair values or respond sluggishly to new information. However, few asset-pricing models relate asset risk premia to

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market frictions such as funding and liquidity constraints. Garleanu–Pedersen (2009a) propose a model in which the CAPM risk premium is boosted when binding funding constraints make

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capital scarce, while Acharya–Pedersen (2005) have adjusted the CAPM to include liquidity-related premia. Illiquidity is the most important market friction. Early studies of liquidity premia focused on the cost (rather than the risk) of illiquidity—they observed that greater trading costs when buying and selling

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(1972) and Lamont–Thaler (2003), on index inclusion effects Shleifer (1986) and Wurgler–Zhuravskaya (2002), on inflation-linked bonds D’Amico et al. (2010), on market frictions Garleanu–Pedersen (2009a), on liquidity Acharya–Pedersen (2005), on disagreement Hong–Stein (2007), and on information asymmetries Vayanos–Woolley (2008). On the efficient markets hypothesis

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regularities or mispricings) as well as growing arbitrage capacity. This trend reversed in 2007–2008. As market liquidity and arbitrage conditions deteriorated, apparent mispricings and market frictions increased. There was clearly less arbitrage capital available, as attempts to arbitrage the mispricings often resulted in losses as de-leveraging made cheap assets even

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month. Few behavioral models try to explain this effect, although short-term overreactions to salient news are a possibility. More common explanations are related to market frictions: the so-called bid–ask bounce and temporary price concessions for large trades. [8] In the spirit of the Griffin–Tversky (1992) distinction between the

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” is my catch-all term for explanations that do not imply investment opportunities for the future: data mining and selection biases, peso problems and learning, market frictions and structural changes. 7.1 RISK PREMIA OR MARKET INEFFICIENCY The two main competing explanations for return predictability are time-varying risk premia and market

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” EXPLANATIONS There are several explanations for market regularities besides the above two. Data mining is the best known, but I also mention peso problems, learning, market frictions, and the changing world. I call all of these explanations mirages because whatever predictability was observed in the past was sample specific and/or has

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problems and learning stories help in interpreting past return predictability but contain no lessons about future profit opportunities. Market frictions Most academic predictability evidence is presented without taking into account trading costs and other market frictions. It is not surprising, then, that paper profits tend to be most consistent in illiquid assets (e.g

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both direct costs and market impact) have been understated. Fortunately, newer studies increasingly adjust profits for trading costs, financing costs, short-selling constraints, and other market frictions. While the limits-to-arbitrage literature explains why speculative capital is generally scarce, these adjustments explain why certain paper regularities are harder to exploit in

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consumption growth and asset returns, unless an extremely high risk aversion coefficient is used. A huge academic literature has tried to reconcile this puzzle, using market frictions (borrowing constraints, limited market participation, incomplete markets, and idiosyncratic risk), non-standard utility functions (habit formation, recursive utility), modified consumption data (durable goods, luxury goods

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strategies; their risk-adjusted returns appeared better than those that motivated the literature on the equity premium puzzle and the value puzzle. Trading costs and market frictions were among the early “explanations” but currencies are highly liquid and the carry strategy requires relatively low turnover. The focus then reverted to risk-based

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various unintended risks to which delta-hedged straddles are exposed—gamma risk between discrete rebalancings, the possibility of jumps (model risk), and the impact of market frictions such as illiquidity and trading costs. Variance swaps have become popular in recent years but are not yet available for all assets. Interpreting implied volatilities

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a risk premium proportional to their delta (and equity market beta, if the CAPM holds). The cross-sectional implication of BSM assumptions (constant volatilities, no market frictions, etc.) is that all options across all strike prices should have the same implied volatility. Thus, real-world deviations from BSM assumptions should explain observed

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market regularities. The rational camp responds that risk stories can explain a surprisingly large part of observed returns without resorting to irrationality—and that various market frictions can make exploiting any remaining opportunities difficult. Specifically, Broadie–Chernov–Johannes (2009) argue that options are often thought to be mispriced because the performance metrics

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generate double-digit negative expected returns and thus explain ATM option evidence without mispricing. Beyond these explanations, there are wide bid–ask spreads and other market frictions to consider. 15.5 OTHER ASSETS Volatility selling appears to be profitable outside equity markets, but not as profitable (or risky) as with equity index

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sample period 1996 to 2008. The opportunity is attractive but actual trading profits are not as consistent as the graph suggests; trading costs and other market frictions could eat up much of the gains. Moreover, the plotted correlations are smoothed averages; shorter dated realized correlations spiked above 75% in October 2008, well

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—Cochrane habit formation model Capital Asset Pricing Model (CAPM) alphas carry strategies Consumption CAPM covariance with “bad times” disagreement models ERP Intertemporal CAPM liquidity-adjusted market frictions market price equation multiple risk factors risk factors risk-adjusted returns risk-based models skewness stock—bond correlation supply—demand volatility Capital Ideas (Bernstein) capitalism

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hyperinflation Ibbotson Associates Ibbotson index Ibbotson, Roger IG see investment-grade bonds ILLIQ price impact proxy illiquidity assets average returns hedge funds long-horizon investors market frictions premium reward—risk ratios see also liquidity illiquidity premium definition liquidity risk premium stocks time-varying implied correlation implied volatility tail risks volatility selling incubation

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lottery approaches LTCM HF management lunar cycle macro-finance models, BRP managers hedge funds PE funds skill styles marginal utility (MU) market-cap-weighted indices market frictions market inefficiency market liquidity market mispricing market price equations market timing endogenous return and risk long-horizon investors tactical forecasting volatility markets adaptive markets hypothesis

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-based returns value premium volatility selling rational learning rational theories asymmetric information covariance with “bad times” disagreement models EMH illiquidity premia investor irrationality marginal utility market frictions market price equations multiple risk factors the “new world” the “old world” rational learning skewness preferences supply—demand time-varying risk premia RE see real

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valuation, ERP rental yield replication strategies reporting bias representativeness repricing effect required returns retail investors return biases return predictability alternative interpretations changing world data mining market frictions market inefficiency peso problems rational learning risk premia return reversal return and risk, endogenous return-based risk factors reversal behavioral finance commodity momentum equity momentum

What's Wrong With Economics: A Primer for the Perplexed

by Robert Skidelsky · 3 Mar 2020 · 290pp · 76,216 words

place at the ‘wrong’, or disequilibrium, prices. This means that equilibrium cannot be proved to be the result of a myriad of voluntary transactions in markets. Frictions in the social world are much more severe than those in physics, because they are caused by the human beings whose behaviour we are trying

The Inner Lives of Markets: How People Shape Them—And They Shape Us

by Tim Sullivan · 6 Jun 2016 · 252pp · 73,131 words

, then there is a vocal contingent out there (“there” being mostly Silicon Valley) that sees technology as the solution. When viewed through the lens of market frictions, the much-hyped notion of the sharing economy can be seen as an effort to bring free-market salvation to bricks, mortars, and automobiles. If

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a room via its predecessors, the classified ads or Craigslist. But let’s not confuse a set of groundbreaking market innovations with the end of market frictions. Yes, there are entire websites devoted to Airbnb horror stories—the trashed homes, the tenant-turned-squatter. There’s an equal number of angry rants

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of us rents our idle real estate assets when we’re out of town and not because we’re old-fashioned. We’ve also experienced market frictions of a more mundane variety. In writing this book we went to Washington to interview George Akerlof of market-for-lemons fame. As a bit

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different from the regulatory shenanigans that its predecessors resorted to. You try to erect what economists call barriers to entry, which are, almost by definition, market frictions. They’re the strategies Uber and every other business employs to try to keep customers from choosing freely among competing options in the marketplace, whether

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billion valuation, you need to create as many frictions as possible for everyone else. Although proponents of the sharing economy tout its ability to reduce market frictions, the only way they’re going to make the kinds of profits they (and their investors) want is to create new ones. That’s something

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the techno-utopian free-market narrative. A great entrepreneur will use technology to create a fantastic new market, then will use technology to set up market frictions to protect it. As entrepreneur and venture capitalist Peter Thiel wrote in the Wall Street Journal, “Competition Is for Losers.”12 Don’t get us

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, auction versus, 96–97 food bank market system, 154–160 Foundations of Economic Analysis (Samuelson), 28 Fourcade, Marion, 20 fraternity rush, 140 free markets See markets frictions, market, 169–174 “Friday Car,” 46 Friedman, Milton, 72, 151 fundamental attribution error, 178 fundamentalists, market, 16–17 Future Shop (Snider and Ziporyn), 42 Gale

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MAD (doctrine of nuclear deterrence by mutually assured destruction), 26 mail-in-bids, for auctions, 83–84 “The Market for Lemons” (Akerlof), 44–51, 64 market frictions, 169–174 market fundamentalists, 16–17 market insights, 14–15 market makers, 107–110, 118–121 markets 18th-century book, 90–91 competitive, 35, 124

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, Carl, 85 sick organizations, 142–143 signaling model applications of, 66–68 commitment signs, 62–66 competitive signaling, 69–71 integrity, 71–75 Silicon Valley, market friction and, 169–173 Skoll, Jeff, 39–40, 43, 51 Smith, Adam, 21 Snider, James, 42 social efficiency, auctions, 89 social well-being, assessing, 22 Solow

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expressions, 62–66 Tanaka, Masahiro, 99 tattoos, as gang markings, 61–62, 67–68 Tauson, Bob, 62 taxi drivers, Uber vs., 169–170, 172 technology, market friction and, 169–173 Tenney, Lester, 12–13, 176 “terms of service” agreements, 6 Theory of Games and Economic Behavior (Morgenstern and von Neumann), 25–27

Ghost Work: How to Stop Silicon Valley From Building a New Global Underclass

by Mary L. Gray and Siddharth Suri · 6 May 2019 · 346pp · 97,330 words

, Switzerland, 2016. © International World Wide Web Conference Committee. Used with permission. All rights reserved. Sara Constance Kingsley, Mary L. Gray, and Siddharth Suri. “Accounting for Market Frictions and Power Asymmetries in Online Labor Markets.” Policy & Internet, 7(4):383–400, 2015. © 2015 Policy Studies Organization. Used with permission by Wiley Periodicals, Inc

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the National Labor Relations Act. In it, Coase argued that businesses had to coordinate their operations, such as finding, hiring, and training workers, to reduce market frictions. The only route to lower costs and to turning a profit hinged on making businesses run as smoothly as possible. In essence, he was the

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Bureau of Economic Research, Cambridge, MA, September 2016. https://doi.org/10.3386/w22667. Kingsley, Sara Constance, Mary L. Gray, and Siddharth Suri. “Accounting for Market Frictions and Power Asymmetries in Online Labor Markets.” Policy & Internet 7, no. 4 (December 1, 2015): 383–400. https://doi.org/10.1002/poi3.111. Kuehn

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on Computer-Supported Cooperative Work and Social Computing, 134–47. New York: ACM, 2016. Kingsley, Sara Constance, Mary L. Gray, and Siddharth Suri. “Accounting for Market Frictions and Power Asymmetries in Online Labor Markets.” Policy & Internet 7, no. 4 (December 1, 2015): 383–400. https://doi.org/10.1002/poi3.111. Yin

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. 2 (December 1, 2010): 16, https://doi.org/10.1145/1869086.1869094. [back] 13. Sara Constance Kingsley, Mary L. Gray, and Siddharth Suri, “Accounting for Market Frictions and Power Asymmetries in Online Labor Markets,” Policy & Internet 7, no. 4 (December 1, 2015): 383–400, https://doi.org/10.1002/poi3.111. See

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’re more interested in how they found out about the HIT. For more details on how we gathered this data, see Kingsley, Gray, and Suri, “Market Frictions,” 383–400, and Gray et al., “The Crowd,” 134–47. [back] 14. See Salehi et al., “We Are Dynamo: Overcoming Stalling and Friction in Collective

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least 30 percent of activities that can technically be automated” by 2055. Manyika et al., Harnessing Automation. [back] 6. Kingsley, Gray, and Suri. “Accounting for Market Frictions,” 383–400. [back] 7. These are actually two of Siddharth’s MTurk worker IDs. [back] 8. David H. Autor, “Why Are There Still So Many

Making Sense of Chaos: A Better Economics for a Better World

by J. Doyne Farmer · 24 Apr 2024 · 406pp · 114,438 words

58 (3): 529–546. Daniels, Marcus G., J. Doyne Farmer, László Gillemot, Giulia Iori and D. Eric Smith. 2003. ‘Quantitative Model of Price Diffusion and Market Friction Based on Trading as a Mechanistic Random Process’. Physical Review Letters 90(10): 108102–108104, doi: 10.1103/PhysRevLett.90.108102. Danielsson, J., P. Embrechts

Trading and Exchanges: Market Microstructure for Practitioners

by Larry Harris · 2 Jan 2003 · 1,164pp · 309,327 words

strategies cheaply. Exchanges like liquidity because it attracts traders to their markets. Regulators like liquidity because liquid markets are often less volatile than illiquid ones. * * * ▶ Market Frictions Economists like liquid markets—securities markets, contract markets, product markets, and labor markets—because their models work better when they do not have to consider

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system therefore are like frictions in a mechanical system. They both slow things down and can ultimately stop all activity. Economists therefore call transaction costs market frictions. ◀ * * * Everyone in the markets has some affect on liquidity. Impatient traders take liquidity. Dealers, limit order traders, and some speculators offer liquidity. Brokers and exchanges

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, 432, 434 estimation methods, 422–23 estimator biases, 428–31 gaming problem, 430–31 and hedging, 188 implicit, 432, 434 intelligent management, 439–40 as market frictions, 394 measurment, 420–41 missed trade opportunity costs, 434, 436–38 and paying the spread, 71 prediction, 438–39 properties of price benchmark estimators, 427

Reinventing the Bazaar: A Natural History of Markets

by John McMillan · 1 Jan 2002 · 350pp · 103,988 words

and demand and peered inside. Game theory has been brought to bear on the processes of exchange. Examining markets up close, the new economics emphasizes market frictions and how they are kept in check. In 2001, this work received recognition with the award of the Nobel Prize in economics to George Akerlof

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thirty years,” Kenneth Arrow said in 2000, “is the development of the importance of information, along with the dispersion of information.”4 Two kinds of market frictions arise from the uneven supply of information. There are search costs: the time, effort, and money spent learning what is available where for how much

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that are firms? Why isn’t everyone an independent contractor instead of a hired employee? The answer is that firms exist as a response to market frictions. Sometimes it is less expensive to run a hierarchy than to use the market. Whether a firm produces its inputs in-house or procures them

Money and Government: The Past and Future of Economics

by Robert Skidelsky · 13 Nov 2018

output movements represent the time-varying Pareto optimum’.67 The New Keynesians preserved the basic framework of the New Classical RBC/DSGE models, but added ‘market frictions’, like monopolistic competition and nominal rigidities, to make the models more applicable to the real world.68 A pp e n di x 7.3