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Liquidity and capital under uncertainty and changing market sentiment: A simple analysis

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  • Bossone, Biagio

Abstract

This study introduces a general approach to investigate resource allocation and asset prices in an economy with uncertainty and shifts in market sentiment. The approach presents a number of key features: first, it proposes a choice-theoretic model that determines the utility that the agents derive from holding assets with different liquidity. Second, it incorporates a variable (endogenously-determined) cost structure of asset liquidation, which reflects the (in)efficiencies of the financial infrastructure and changes in market moods. Third, it also incorporates a model of expectations formation under uncertainty and changing market sentiment. While rich in structure, the approach offers a simple analytical framework to investigate resource allocation decision and asset price dynamics under various sources of uncertainty, and to explore the micro-economics of speculative bubbles and boom–bust sequences. The use of a possible market-specific prudential policy tool is discussed.

Suggested Citation

  • Bossone, Biagio, 2014. "Liquidity and capital under uncertainty and changing market sentiment: A simple analysis," Review of Financial Economics, Elsevier, vol. 23(2), pages 98-105.
  • Handle: RePEc:eee:revfin:v:23:y:2014:i:2:p:98-105
    DOI: 10.1016/j.rfe.2013.10.003
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    References listed on IDEAS

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    1. Nouriel Roubini, 2006. "Why Central Banks Should Burst Bubbles," International Finance, Wiley Blackwell, vol. 9(1), pages 87-107, May.
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    Cited by:

    1. Bossone, Biagio, 2014. "Secular stagnation," Economics Discussion Papers 2014-47, Kiel Institute for the World Economy (IfW).

    More about this item

    Keywords

    Money and asset utility; Bubbles and bursts; Information; Liquidity; Market sentiment or mood; Optimistic (pessimistic) expectations; Liquidation (transaction) costs; Resource allocation; Uncertainty;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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