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Alchemy of Financial Innovation: Securitization, Liquidity and Optimal Monetary Policy

Author

Listed:
  • Jungu Yang

    (Economic Research Institute, Bank of Korea)

Abstract

This paper provides a theoretical model to explain how securitization affects the overall liquidity and welfare of an economy, an under-discussed area in the literature. By applying an overlapping generations model with random-relocation shocks, the effects of securitization are analyzed in three different hypothetical situations: 1. only one region of the economy issues securities, 2. all regions issue securities with the same capital productivity, and 3. all regions issue securities, but capital productivity is disparate across regions. Asset securitization plays a role in supplying alternative liquid assets (fiat money). As the economy can invest its resources more efficiently in high-yielding illiquid assets (capital) due to securitization, both consumption and welfare increase overall. Optimal monetary policy follows the Friedman rule in cases 1. and 2. However, the rule does not apply in case 3.

Suggested Citation

  • Jungu Yang, 2019. "Alchemy of Financial Innovation: Securitization, Liquidity and Optimal Monetary Policy," Working Papers 2019-10, Economic Research Institute, Bank of Korea.
    • Handle: RePEc:bok:wpaper:1910
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    File URL: http://papers.bok.or.kr/RePEc_attach/wpaper/english/wp-2019-10.pdf
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    More about this item

    Keywords

    Securitization; Liquidity; Friedman Rule; Monetary Policy;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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