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Private and public liquidity provision in over-the-counter markets

Author

Listed:
  • Arseneau, David M.

    (Federal Reserve Board)

  • Rappoport W., David E.

    (Federal Reserve Board)

  • Vardoulakis, Alexandros P.

    (Federal Reserve Board)

Abstract

We show that trade frictions in OTC markets result in inefficient private liquidity provision. We develop a dynamic model of market-based financial intermediation with a two-way interaction between primary credit markets and secondary OTC markets. Private allocations are generically inefficient because investors and firms fail to internalize how their actions affect liquidity in secondary markets. This inefficiency can lead to liquidity that is suboptimally low or high compared to the second best, providing a rationale for the regulation and public provision of liquidity. Moreover, our model characterizes a transmission channel of quantitative easing or tightening operating through liquidity premia.

Suggested Citation

  • Arseneau, David M. & Rappoport W., David E. & Vardoulakis, Alexandros P., 2020. "Private and public liquidity provision in over-the-counter markets," Theoretical Economics, Econometric Society, vol. 15(4), November.
    • Handle: RePEc:the:publsh:3419
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    More about this item

    Keywords

    Liquidity provision; market liquidity; over-the-counter markets; otc; quantitative easing; quantitative tightening; monetary policy normalization;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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