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Limited Market Participation and Volatility of Asset Prices (Revision of 14-91) (Reprint 043)

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  • Franklin Allen
  • Douglas Gale

Abstract

Traditional theories of asset pricing assume there is a complete market participation, in the sense that all investors participate in all markets. In that case, preferences shocks typically have only a small effect on asset prices and are not an important determinant of asset price volatility. However, there is considerable empirical evidence that most investors participate in a limited number of markets. We show that limited market participation can amplify the effect of preference shocks, so that an arbitrarily small degree of aggregate uncertainty about preferences causes a large degree of price volatility. We also show there may exist Pareto-ranked equilibria, where the Pareto-preferred equilibrium is characterized by a different pattern of participation and lower volatility.

Suggested Citation

  • Franklin Allen & Douglas Gale, "undated". "Limited Market Participation and Volatility of Asset Prices (Revision of 14-91) (Reprint 043)," Rodney L. White Center for Financial Research Working Papers 2-92, Wharton School Rodney L. White Center for Financial Research.
    • Handle: RePEc:fth:pennfi:2-92
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    Cited by:

    1. Elizabeth Berko & John Clark, 1997. "Foreign investment fluctuations and emerging market stock returns: the case of Mexico," Staff Reports 24, Federal Reserve Bank of New York.
    2. Terence Khoo & David Hartzell & Martin Hoesli, 1993. "An Investigation of the Change in Real Estate Investment Trust Betas," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 21(2), pages 107-130, June.

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