N°25-97: Benign Granularity in Asset Markets

We develop a tractable model to study how asset concentration among a few large investors impacts asset prices and liquidity. Consistent with existing empirical evidence: (i) greater concentration is associated with higher volatility and returns, and (ii) large investors' turnover share is smaller than their proportion of total wealth. Surprisingly, higher concentration enhances liquidity, aligning with our new empirical findings. We show that increased concentration can benefit all investors in sufficiently non-competitive markets. We link the wedge between competitive and non-competitive outcomes to the Herfindahl-Hirschman Index measuring wealth concentration. The wedge can remain positive even in large markets.