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Liquidity and Asset Prices

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  • Raphael A. Espinoza

    ()

  • Dimitrios P. Tsomocos

    ()

Abstract

We show in an exchange economy with liquidity constraints that the volume of trade and asset prices depend on both the supply of liquidity by the Central Bank and on the liquidity of assets and commodities. As a result, monetary aggregates are informative for the assessment of economic developments and the conduct of monetary policy. We also show that the positive correlation between state prices and the future spot rate generates a risk-premium in the term structure of interest rates, even in absence of aggregate uncertainty. These results do not obtain in representative agent models but hold in any monetary economy with heterogeneous agents and short-term liquidity effects, where monetary costs act as transaction costs and the quantity theory of money is verified.

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File URL: http://www.finance.ox.ac.uk/file_links/finecon_papers/2008fe28.pdf
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Bibliographic Info

Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2008fe28.

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Length: 24
Date of creation: 2008
Date of revision:
Handle: RePEc:sbs:wpsefe:2008fe28

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Web page: http://www.finance.ox.ac.uk
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Keywords: liquidity; cash-in-advance constraints; term structure of interest rates;

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  1. Raphaƫl Espinoza & Charles. Goodhart & Dimitrios Tsomocos, 2009. "State prices, liquidity, and default," Economic Theory, Springer, vol. 39(2), pages 177-194, May.
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Cited by:
  1. Charles A. E. Goodhart & Dimitrios P. Tsomocos, 2011. "The Role of Default in Macroeconomics," IMES Discussion Paper Series 11-E-23, Institute for Monetary and Economic Studies, Bank of Japan.
  2. Dimitrios Tsomocos & Juan Francisco Martinez Sepulveda, 2012. "Liquidity effects on asset prices, financial stability and economic resilience," 2012 Meeting Papers 916, Society for Economic Dynamics.

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