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Crises and liquidity in over-the-counter markets

  • Lagos, Ricardo
  • Rocheteau, Guillaume
  • Weill, Pierre-Olivier

We study the efficiency of liquidity provision by dealers and the desirability of policy intervention in over-the-counter (OTC) markets during crises. We emphasizes two OTC frictions: finding counterparties takes time, and trade is bilateral and involves bargaining. We model a crisis as a shock that reduces investorsʼ asset demands, lasting until a random recovery time. In this context, dealers can provide liquidity to investors by accumulating asset inventories. When OTC frictions are severe, even well capitalized dealers may not find it privately optimal to accumulate inventories, and direct purchase by the government can improve welfare.

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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 146 (2011)
Issue (Month): 6 ()
Pages: 2169-2205

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Handle: RePEc:eee:jetheo:v:146:y:2011:i:6:p:2169-2205
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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