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Liquidity and Asset Prices

  • Raphael A. Espinoza
  • Dimitrios P. Tsomocos

We show in an exchange economy with liquidity constraints that the volume of trade and asset prices depend on both the supply of liquidity by the Central Bank and on the liquidity of assets and commodities.� As a result, monetary aggregates are informative for the assessment of economic developments and the conduct of monetary policy.� We also show that the positive correlation between state prices and the future spot rate generates a risk-premium in the term structure of interest rates, even in absence of aggregate uncertainty.� These results do not obtain in representative agent models but hold in any monetary economy with heterogeneous agents and short-term liquidity effects, where monetary costs act as transaction costs and the quantity theory of money is verified.

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File URL: http://economics.ouls.ox.ac.uk/14085/1/2008fe28.pdf
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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 2008fe28.

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Date of creation: 01 Jul 2008
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Handle: RePEc:oxf:wpaper:2008fe28
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  1. Dimitrios P Tsomocos, 2006. "Generic Determinacy and Money Non-Neutrality of International Monetary Equilibria," Economics Series Working Papers 2006-FE-07, University of Oxford, Department of Economics.
  2. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  3. Raphaël Espinoza & Charles. Goodhart & Dimitrios Tsomocos, 2009. "State prices, liquidity, and default," Economic Theory, Springer, vol. 39(2), pages 177-194, May.
  4. Backus, David K. & Gregory, Allan W. & Zin, Stanley E., 1989. "Risk premiums in the term structure : Evidence from artificial economies," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 371-399, November.
  5. Dubey, Pradeep & Geanakoplos, John, 2003. "Monetary equilibrium with missing markets," Journal of Mathematical Economics, Elsevier, vol. 39(5-6), pages 585-618, July.
  6. Grossman, S J & Melino, Angelo & Shiller, Robert J, 1987. "Estimating the Continuous-Time Consumption-Based Asset-Pricing Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(3), pages 315-27, July.
  7. 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.
  8. Min Fan, 2006. "Heterogeneous Beliefs, the Term Structure and Time-varying Risk Premia," Annals of Finance, Springer, vol. 2(3), pages 259-285, July.
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