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Endogenous liquidity and volatility

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  • Rocheteau, Guillaume
  • Wang, Lu

Abstract

Is asset liquidity a source of price volatility? We answer this question within a continuous-time, New Monetarist economy under extrinsic uncertainty where the role of an asset to finance expenditure shocks depends on its pledgeability. If assets are intrinsically valuable and pledgeability is exogenous, then their prices are invariant to extrinsic uncertainty – unlike environments with discrete-time pricing that can feature sunspot equilibria. We derive conditions under which extrinsic uncertainty matters when pledgeability is endogenous and varies with the asset price or its rate of return. In the latter case, we link sunspot equilibria to deterministic cycles.

Suggested Citation

  • Rocheteau, Guillaume & Wang, Lu, 2023. "Endogenous liquidity and volatility," Journal of Economic Theory, Elsevier, vol. 210(C).
    • Handle: RePEc:eee:jetheo:v:210:y:2023:i:c:s0022053123000480
    DOI: 10.1016/j.jet.2023.105652
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    More about this item

    Keywords

    Search; Money; Liquidity; Extrinsic uncertainty;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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