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Endogenous Liquidity and the Business Cycle

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  • Saki Bigio

    (Columbia Business School)

Abstract

I study an economy where asymmetric information about the quality of capital endogenously determines liquidity. Liquid funds are key to relaxing financial constraints on investment and employment. These funds are obtained by selling capital or using it as collateral. Liquidity is determined by balancing the costs of obtaining liquidity under asymmetric information against the benefits of relaxing financial constraints. Aggregate fluctuations follow increases in the dispersion of capital quality, which raise the cost of obtaining liquidity. An estimated version of the model can generate patterns for quantities and credit conditions similar to the Great Recession.

Suggested Citation

  • Saki Bigio, 2014. "Endogenous Liquidity and the Business Cycle," Working Papers 2014-24, Peruvian Economic Association.
  • Handle: RePEc:apc:wpaper:2014-024
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    Keywords

    Liquidity; Asymmetric Information; Business Cycles;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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