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Liquidity and the threat of fraudulent assets

  • Yiting Li
  • Guillaume Rocheteau
  • Pierre-Olivier Weill

We study an over-the-counter (OTC) market with bilateral meetings and bargaining where the usefulness of assets, as means of payment or collateral, is limited by the threat of fraudulent practices. We assume that agents can produce fraudulent assets at a positive cost, which generates endogenous upper bounds on the quantity of each asset that can be sold, or posted as collateral in the OTC market. Each endogenous, asset-specific, resalability constraint depends on the vulnerability of the asset to fraud, on the frequency of trade, and on the current and future prices of the asset. In equilibrium, the set of assets can be partitioned into three liquidity tiers, which differ in their resalability, their prices, their sensitivity to shocks, and their responses to policy interventions. The dependence of an asset’s resalability on its price creates a pecuniary externality, which leads to the result that some policies commonly thought to improve liquidity can be welfare reducing.

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Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 1124.

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Date of creation: 2011
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Handle: RePEc:fip:fedcwp:1124
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  1. Xavier Gabaix & Arvind Krishnamurthy & Olivier Vigneron, 2007. "Limits of Arbitrage: Theory and Evidence from the Mortgage-Backed Securities Market," Journal of Finance, American Finance Association, vol. 62(2), pages 557-595, 04.
  2. Holmström, Bengt, 2011. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262015783, June.
  3. Veronica Guerrieri & Robert Shimer & Randall Wright, 2009. "Adverse Selection in Competitive Search Equilibrium," NBER Working Papers 14915, National Bureau of Economic Research, Inc.
  4. Barnett, William A & Fisher, Douglas & Serletis, Apostolos, 1992. "Consumer Theory and the Demand for Money," Journal of Economic Literature, American Economic Association, vol. 30(4), pages 2086-2119, December.
  5. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
  6. James Vickery & Joshua Wright, 2010. "TBA trading and liquidity in the agency MBS market," Staff Reports 468, Federal Reserve Bank of New York.
  7. Thomas J. Sargent & Francois R. Velde, 1997. "The big problem of small change," Working Paper Series, Macroeconomic Issues WP-97-08, Federal Reserve Bank of Chicago.
  8. Pierre-Olivier Weill, 2004. "Liquidity Premia in Dynamic Bargaining Markets," Econometric Society 2004 North American Winter Meetings 648, Econometric Society.
  9. Freeman, Scott, 1985. "Transactions Costs and the Optimal Quantity of Money," Journal of Political Economy, University of Chicago Press, vol. 93(1), pages 146-57, February.
  10. 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.
  11. Shouyong Shi, 2008. "Efficiency Improvement from Restricting the Liquidity of Nominal Bonds," Working Papers tecipa-329, University of Toronto, Department of Economics.
  12. Guillaume Rocheteau, 2009. "A monetary approach to asset liquidity," Working Paper 0901, Federal Reserve Bank of Cleveland.
  13. Edward J. Green & Warren E. Weber, 1996. "Will the new $100 bill decrease counterfeiting?," Working Papers 571, Federal Reserve Bank of Minneapolis.
  14. Shouyong Shi, 2011. "Liquidity, Assets and Business Cycles," Working Papers tecipa-434, University of Toronto, Department of Economics.
  15. Veronica Guerrieri & Robert Shimer, 2012. "Dynamic Adverse Selection: A Theory of Illiquidity, Fire Sales, and Flight to Quality," NBER Working Papers 17876, National Bureau of Economic Research, Inc.
  16. Ed Nosal & Neil Wallace, 2004. "A model of (the threat of) counterfeiting," Working Paper 0401, Federal Reserve Bank of Cleveland.
  17. Kenneth A. Snowden, 2010. "Covered Farm Mortgage Bonds in the Late Nineteenth Century U.S," NBER Working Papers 16242, National Bureau of Economic Research, Inc.
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