This is considerable empirical evidence that most investors participate in only a limited number of markets. Once the participation decision is endogenized, the liquidity of a market depends on the characteristics of the investors who choose to participate. In particular, the liquidity of the market depends on the amount of "cash in the market" which in turn depends on the investors' liquidity preference. If the only investors who choose to participate in the market have a low degree of liquidity preference, investors will on average hold a small reserve of cash and liquidity trades will cause large changes in prices. We study a model with these features and obtain three results. First, limited market participation can amplify the effect of liquidity trading relative to full participation; under certain circumstances, an arbitrarily small aggregate shock in the form of liquidity trading can cause a large degree of price volatility. Second, there exist multiple equilibria with very different levels of asset-price volatility. Third, under plausible conditions the equilibria can be Pareto-ranked; the Pareto-preferred equilibrium is characterized by greater participation and lower volatility.
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