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Stock-Flow Models of Market Friction and Search

Smith, Eric 'Stock-Flow Models of Market Friction and Search.' In: Hamilton, Jonathan H and Dixit, Avinash and Edwards, Sebastian and Judd, Kenneth, (eds.) Oxford Research Encyclopedia of Economics and Finance. Oxford University Press (OUP). (In Press)

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Stock-flow matching is a simple and elegant framework of dynamic trade in differentiated goods. Flows of entering traders match and exchange with the stocks of previously unsuccessful traders on the other side of the market. A buyer or seller who enters a market for a single, indivisible good such as a job or a home does not experience impediments to trade. All traders are fully informed about the available trading options; however, each of the available options in the stock on the other side of the market may or may not be suitable. If fortunate, this entering trader immediately finds a viable option in the stock of available opportunities and trade occurs straightaway. If unfortunate, none of the available opportunities suit the entrant. This buyer or seller now joins their stock of unfulfilled traders who must wait for a new, suitable partner to enter. Three striking empirical regularities emerge from this microstructure. First, as the stock of buyers does not match with the stock of sellers, but with the flow of new sellers, the flow of new entrants becomes an important explanatory variable for aggregate trading rates. Second, the traders' exit rates from the market are initially high, but if they fail to match quickly the exit rates become substantially slower. Third, these exit rates depend on different variables at different phases of an agent's stay in the market. The probability that a new buyer trades successfully depends only on the stock of sellers in the market. In contrast, the exit rate of an old buyer depends positively on the flow of new sellers, negatively on the stock of old buyers, and is independent of the stock of sellers. These three empirical relationships not only differ from those found in the familiar search literature but also conform with empirical evidence ob-served from unemployment outflows. Moreover, adopting the stock-flow ap-proach enriches our understanding of output dynamics, employment flows, and aggregate economic performance. These trading mechanics generate en-dogenous price dispersion and price dynamics - prices depend on whether the buyer or the seller is the recent entrant and on how many viable traders were waiting for the entrant which varies over time. The stock-flow structure has provided insights about housing, temporary employment, and taxi cab markets.

Item Type: Book Section
Uncontrolled Keywords: marketplace matching, trading mechanics, hazard rates, duration dependence, unemployment flows, job search
Divisions: Faculty of Social Sciences > Economics, Department of
Depositing User: Elements
Date Deposited: 29 Jun 2020 18:46
Last Modified: 29 Jun 2020 18:46

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