Monetary Policy, Asset Prices, and Liquidity in Over-the-Counter Markets
AbstractWe revisit a traditional topic in monetary economics: the relationship between asset prices and monetary policy. We study a model in which money helps facilitate trade in decentralized markets, as in Lagos andWright (2005), and real assets are traded in an over-the-counter (OTC) market, as in Duffie, Gˆarleanu, and Pedersen (2005). Agents wish to hold liquid portfolios, but liquidity comes at a cost: inflation. The OTC market serves as a secondary asset market, in which agents can rebalance their positions depending on their liquidity needs. Hence, a contribution of our paper is to provide a micro-founded explanation of the assumption that different investors have different valuations for the same asset, which is the key for generating gains from trade in the Duffie et al framework. In equilibrium, assets can be priced higher than their fundamental value because they help agents avoid the inflation tax.
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Bibliographic InfoPaper provided by University of California, Davis, Department of Economics in its series Working Papers with number 1220.
Date of creation: 25 Sep 2012
Date of revision:
monetary-search models; liquidity; asset prices; over-the-counter markets;
Find related papers by JEL classification:
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-10-06 (All new papers)
- NEP-CBA-2012-10-06 (Central Banking)
- NEP-DGE-2012-10-06 (Dynamic General Equilibrium)
- NEP-MAC-2012-10-06 (Macroeconomics)
- NEP-MON-2012-10-06 (Monetary Economics)
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