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Uncertainty and Liquidity

  • Alberto Giovannini
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    This paper studies a model where money is valued for the liquidity services it provides in the future. These liquidity services cannot be provided by any other asset. Changes in expectations of the value of future liquidity services affect the desired proportions of money and other assets in agents' portfolios, and, as a result, they change nominal interest rates and real stock prices. The paper concentrates on the effects of stochastic fluctuations in the distribution of exogenous shocks. I find that changes in dividend risk have effects opposite to those in standard dynamic portfolio models without money. Furthermore, shifts between money and other assets that are driven by precautionary liquidity demand make nominal interest rates capture information about the uncertainty in the economy more accurately than any other prices in the asset markets.

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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2296.

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    Date of creation: Jun 1987
    Date of revision:
    Publication status: published as Journal of Monetary Economics, Vol. 23, pp. 239-258, (1989).
    Handle: RePEc:nbr:nberwo:2296
    Note: ME
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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    2. Stulz, ReneM., 1986. "Interest rates and monetary policy uncertainty," Journal of Monetary Economics, Elsevier, vol. 17(3), pages 331-347, May.
    3. Andrew Abel, . "Stock Prices Under Time-Varying Dividend Risk: An Exact Solution in an Infinite-Horizon General Equilibrium Model," Rodney L. White Center for Financial Research Working Papers 15-88, Wharton School Rodney L. White Center for Financial Research.
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    6. Mascaro, Angelo & Meltzer, Allan H., 1983. "Long- and short-term interest rates in a risky world," Journal of Monetary Economics, Elsevier, vol. 12(4), pages 485-518, November.
    7. Domowitz, Ian & Hakkio, Craig S., 1985. "Conditional variance and the risk premium in the foreign exchange market," Journal of International Economics, Elsevier, vol. 19(1-2), pages 47-66, August.
    8. Poterba, James M & Summers, Lawrence H, 1986. "The Persistence of Volatility and Stock Market Fluctuations," American Economic Review, American Economic Association, vol. 76(5), pages 1142-51, December.
    9. Litterman, Robert B & Weiss, Laurence M, 1985. "Money, Real Interest Rates, and Output: A Reinterpretation of Postwar U.S. Data," Econometrica, Econometric Society, vol. 53(1), pages 129-56, January.
    10. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
    11. Robert S. Pindyck, 1983. "Risk, Inflation, and the Stock Market," NBER Working Papers 1186, National Bureau of Economic Research, Inc.
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    13. John Y. Campbell, 1985. "Stock Returns and the Term Structure," NBER Working Papers 1626, National Bureau of Economic Research, Inc.
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    15. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
    16. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-34, June.
    17. Malkiel, Burton G, 1979. "The Capital Formation Problem in the United States," Journal of Finance, American Finance Association, vol. 34(2), pages 291-306, May.
    18. Selden, Larry, 1979. "An OCE Analysis of the Effect of Uncertainty on Saving under Risk Preference Independence," Review of Economic Studies, Wiley Blackwell, vol. 46(1), pages 73-82, January.
    19. Svensson, Lars E O, 1985. "Money and Asset Prices in a Cash-in-Advance Economy," Journal of Political Economy, University of Chicago Press, vol. 93(5), pages 919-44, October.
    20. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-53, October.
    21. Fama, Eugene F, 1982. "Inflation, Output, and Money," The Journal of Business, University of Chicago Press, vol. 55(2), pages 201-31, April.
    22. Stockman, Alan C, 1980. "A Theory of Exchange Rate Determination," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 673-98, August.
    23. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March.
    24. Giovannini, Alberto & Jorion, Philippe, 1987. "Interest rates and risk premia in the stock market and in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 6(1), pages 107-123, March.
    25. James Tobin, 1956. "Liquidity Preference as Behavior Towards Risk," Cowles Foundation Discussion Papers 14, Cowles Foundation for Research in Economics, Yale University.
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