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Recognizability and Liquidity of Assets

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  • Young Sik Kim

    () (Department of Economics & SIRFE, Seoul National University Seoul, Korea)

  • Manjong Lee

    () (Department of Economics, Korea University, Seoul, Republic of Korea)

Abstract

This paper incorporates the recognizability of assets explicitly into the standard search model of exchange to determine the liquidity returns as an equilibrium outcome. Assuming that money is universally recognizable but bond is not, the two types of the single-coincidence meetings arise?one where both money and bond are accepted and the other where only money is accepted as medium of exchange?depending on a seller¡¯s strategy of accepting or rejecting the bond of unrecognized quality and a buyer¡¯s strategy of carrying the counterfeit bond. The equilibrium restrictions imply that the liquidity differentials between money and bond tend to increase with the recognizability problem. With the relatively mild recognizability problem, there only exists an equilibrium where all the buyers bring the authentic bond to the decentralized market and sellers always accept the bond of unrecognized quality, and hence money and bond become equally liquid. As the recognizability problem becomes sufficiently severe, there only exists an equilibrium where some buyers bring the counterfeit bond, but sellers randomize between accepting and rejecting the bond of unrecognized quality. Money commands higher liquidity than bond by providing the additional liquidity service when sellers reject the bond of unrecognized quality as well as when they recognize the counterfeit bond. The coexistence of money and bond requires a higher full (liquidity augmented) return for bond than money, implying a positive liquidity premium.

Suggested Citation

  • Young Sik Kim & Manjong Lee, 2012. "Recognizability and Liquidity of Assets," Discussion Paper Series 1206, Institute of Economic Research, Korea University.
  • Handle: RePEc:iek:wpaper:1206
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    References listed on IDEAS

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    Cited by:

    1. Guillaume Rocheteau, 2009. "A monetary approach to asset liquidity," Working Paper 0901, Federal Reserve Bank of Cleveland.
    2. Ricardo Lagos, 2008. "The Research Agenda: Ricardo Lagos on Liquidity and the Search Theory of Money," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 10(1), November.
    3. Guillaume Rocheteau, 2009. "Information and liquidity: a discussion," Working Paper 0902, Federal Reserve Bank of Cleveland.

    More about this item

    Keywords

    recognizability; liquidity; asset prices;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

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