The Role of Trading Frictions in Real Asset Markets

Abstract

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 use data on commercial aircraft markets to empirically investigate whether trading frictions vary with the size of the asset market. Intuitively, it is more difficult to sell assets that have a thin 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, when markets for firms' assets are thin, firms' average productivity and capacity utilization are lower, and the dispersions of productivity and of capacity utilization are higher. In turn, prices of assets with a thin market are, on average, lower and have a higher dispersion, since prices depend on firms' productivity and capacity utilization.The empirical analysis confirms that trading frictions vary with the size of the market, as aircraft with a thinner market have: 1) lower turnover; 2) lower capacity utilization; 3) higher dispersion of utilization levels; 4) lower mean prices; and 5) higher dispersion of transaction prices.