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Monetary Policy, Asset Prices, and Liquidity in Over-the-Counter Markets

  • Athanasios Geromichalos
  • Lucas Herrenbrueck

    (Department of Economics, University of California Davis)

We revisit a traditional topic in monetary economics: the relationship between asset prices and monetary policy. We study a model in which money helps facilitate trade in decentralized markets, as in Lagos andWright (2005), and real assets are traded in an over-the-counter (OTC) market, as in Duffie, Gˆarleanu, and Pedersen (2005). Agents wish to hold liquid portfolios, but liquidity comes at a cost: inflation. The OTC market serves as a secondary asset market, in which agents can rebalance their positions depending on their liquidity needs. Hence, a contribution of our paper is to provide a micro-founded explanation of the assumption that different investors have different valuations for the same asset, which is the key for generating gains from trade in the Duffie et al framework. In equilibrium, assets can be priced higher than their fundamental value because they help agents avoid the inflation tax.

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File URL: http://wp.econ.ucdavis.edu/12-20.pdf
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Paper provided by University of California, Davis, Department of Economics in its series Working Papers with number 1220.

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Length: 41
Date of creation: 25 Sep 2012
Date of revision:
Handle: RePEc:cda:wpaper:12-20
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  1. Guillaume Rocheteau & Randall Wright, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," PIER Working Paper Archive 03-031, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  2. Ricardo Lagos & Guillaume Rocheteau, 2007. "Liquidity in asset markets with search frictions," Working Paper 0706, Federal Reserve Bank of Cleveland.
  3. Aleksander Berentsen & Christopher J. Waller, 2009. "Outside versus inside bonds: a Modigliani-Miller type result for liquidity constrained economies," Working Papers 2009-056, Federal Reserve Bank of St. Louis.
  4. Pierre-Olivier Weill & Guillaume Rocheteau & Ricardo Lagos, 2010. "Crises and Liquidity in Over-the-counter Markets," 2010 Meeting Papers 500, Society for Economic Dynamics.
  5. Benjamin Lester & Andrew Postlewaite & Randall Wright, 2008. "Information, Liquidity and Asset Prices," PIER Working Paper Archive 08-039, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  6. Boel, Paola & Camera, Gabriele, 2006. "Efficient monetary allocations and the illiquidity of bonds," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1693-1715, October.
  7. Aleksander Berentsen & Gabriele Camera, 2004. "Money, Credit, and Banking," 2004 Meeting Papers 473, Society for Economic Dynamics.
  8. Rocheteau, Guillaume, 2011. "Payments and liquidity under adverse selection," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 191-205.
  9. Jonathan Chiu & Thorsten V. Koeppl, 2011. "Trading Dynamics with Adverse Selection and Search: Market Freeze, Intervention and Recovery," Working Papers 11-30, Bank of Canada.
  10. Athanasios Geromichalos & Juan M Licari & Jose Suarez-Lledo, 2007. "Monetary Policy and Asset Prices," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(4), pages 761-779, October.
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