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Recognizability and Liquidity of Assets

  • Young Sik Kim

    ()

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

  • Manjong Lee

    ()

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

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    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.

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    File URL: http://econ.korea.ac.kr/~ri/WorkingPapers/w1206.pdf
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    Paper provided by Institute of Economic Research, Korea University in its series Discussion Paper Series with number 1206.

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    Date of creation: 2012
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    Handle: RePEc:iek:wpaper:1206
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    1. Aruoba, S. Boragan & Waller, Christopher J. & Wright, Randall, 2011. "Money and capital," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 98-116, March.
    2. 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.
    3. 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.
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