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Search-Based Endogenous Illiquidity and the Macroeconomy

  • Wei Cui
  • Sören Radde

We endogenize asset liquidity in a dynamic general equilibrium model with search frictions on asset markets. In the model, asset liquidity is tantamount to the ease of issuance and resaleability of private financial claims, which is driven by investors' participation on the search market. Limited resaleability of private claims creates a role for liquid assets, such as government bonds or fiat money, to ease funding constraints. We show that liquidity and asset prices positively co-move. When the capacity of the asset market to channel funds to entrepreneurs deteriorates, the hedging value of liquid assets increases. Our model is thus able to match the flight to liquidity observed during recessions. Finally, we show that investors' search market participation is more intense in a constrained efficient economy.

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File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.441320.de/dp1367.pdf
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Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 1367.

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Length: 45 p.
Date of creation: 2014
Date of revision:
Handle: RePEc:diw:diwwpp:dp1367
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