Asset markets can achieve efficiency in the directed search framework

Using a directed search model, modified from random matching, this paper investigates how trading frictions in asset markets affect portfolio choices, asset prices, and welfare. By solving the model numerically, it is demonstrated that the asset price increases (decreases) in the matching efficiency, if the relative risk aversion is smaller (larger) than unity. Efficient asset allocation is achieved in the directed search framework, while random matching is known not to achieve efficient allocation.