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Liquidity and asset prices in a monetary model with OTC asset markets

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  • Mattesini, Fabrizio
  • Nosal, Ed

Abstract

We study how asset prices are affected by the amount of liquidity that is available in over-the-counter asset markets where dealers post prices and quantities at which they are willing to buy and sell assets. We find that higher levels of market liquidity lead to higher asset prices and lower bid–ask spreads. Hence, an increase in inflation—which lowers market liquidity—increases asset returns and decreases asset prices. When agents' immediate consumption needs are stochastic, asset prices will fluctuate even though asset fundamentals are unchanging. The fluctuations in asset prices reflect the stochastic availability of market liquidity that results from agents' changing consumption opportunities.

Suggested Citation

  • Mattesini, Fabrizio & Nosal, Ed, 2016. "Liquidity and asset prices in a monetary model with OTC asset markets," Journal of Economic Theory, Elsevier, vol. 164(C), pages 187-217.
    • Handle: RePEc:eee:jetheo:v:164:y:2016:i:c:p:187-217
    DOI: 10.1016/j.jet.2015.11.001
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    More about this item

    Keywords

    Liquidity; Asset pricing; OTC markets; Inflation;
    All these keywords.

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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