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Collateral restrictions and liquidity under-supply: a simple model

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  • Ana Fostel

    ()

  • John Geanakoplos

    ()

Abstract

We show that very little is needed to create liquidity under-supply in equilibrium. Credit constraints on demand by themselves can cause an under-supply of liquidity, without the uncertainty, intermediation, asymmetric information or complicated international financial framework used in other models in the literature. We show that the under-supply is a non-monotone function of the demand distortion that causes it, a result that may have interesting implications for emerging markets economies. Finally, when we make the credit constraint endogenous, the inefficiency can be large due to the presence of a multiplier.

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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 35 (2008)
Issue (Month): 3 (June)
Pages: 441-467

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Handle: RePEc:spr:joecth:v:35:y:2008:i:3:p:441-467

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Related research

Keywords: Liquidity under-supply; Credit constraint; Non-monotonicity; Multiplier; Collateral equilibrium; D51; E44; F30; G15;

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References

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  1. Robert A. Jones & Joseph M. Ostroy, 1979. "Flexibilty and Uncertainty," UCLA Economics Working Papers 163, UCLA Department of Economics.
  2. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
  3. Martin Shubik, 2000. "The Theory of Money," Working Papers 00-03-021, Santa Fe Institute.
  4. Stephen Morris & Hyun Song Shin, 2004. "Liquidity Black Holes," Review of Finance, Springer, vol. 8(1), pages 1-18.
  5. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
  6. Roberto Chang & Andrés Velasco, 2000. "Liquidity Crises in Emerging Markets: Theory and Policy," NBER Chapters, in: NBER Macroeconomics Annual 1999, Volume 14, pages 11-78 National Bureau of Economic Research, Inc.
  7. Diamond, Peter A, 1984. "Money in Search Equilibrium," Econometrica, Econometric Society, vol. 52(1), pages 1-20, January.
  8. Douglas W. Diamond & Raghuram G. Rajan, 2003. "Liquidity Shortages and Banking Crises," NBER Working Papers 10071, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Weerachart Kilenthong, 2011. "Collateral premia and risk sharing under limited commitment," Economic Theory, Springer, vol. 46(3), pages 475-501, April.
  2. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715, Cowles Foundation for Research in Economics, Yale University.
  3. M. Peiris & Alexandros Vardoulakis, 2013. "Savings and default," Economic Theory, Springer, vol. 54(1), pages 153-180, September.
  4. Fostel, Ana & Geanakoplos, John, 2012. "Why does bad news increase volatility and decrease leverage?," Journal of Economic Theory, Elsevier, vol. 147(2), pages 501-525.
  5. Matthias Fleckenstein & Francis A. Longstaff & Hanno Lustig, 2010. "Why Does the Treasury Issue Tips? The Tips–Treasury Bond Puzzle," NBER Working Papers 16358, National Bureau of Economic Research, Inc.
  6. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715R, Cowles Foundation for Research in Economics, Yale University, revised Jan 2010.
  7. Franklin Allen, 2010. "Comment on "The Leverage Cycle"," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 67-73 National Bureau of Economic Research, Inc.
  8. Guembel, Alexander & Sussman, Oren, 2010. "Liquidity, Contagion and Financial Crisis," IDEI Working Papers 664, Institut d'Économie Industrielle (IDEI), Toulouse.
  9. Eric van Wincoop & Cedric Tille & Philippe Bacchetta, 2010. "On the Dynamics of Leverage, Liquidity, and Risk," 2010 Meeting Papers 393, Society for Economic Dynamics.

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