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Information, Liquidity and Asset Prices

  • Benjamin Lester

    ()

    (Department of Economics, University of Western Ontario)

  • Andrew Postlewaite

    ()

    (Department of Economics, University of Pennsylvania)

  • Randall Wright

    ()

    (Department of Economics, University of Pennsylvania)

We study economies with multiple assets that are valued both for their return and liquidity. Exchange occurs in decentralized markets with frictions making a medium of exchange essential. Some assets are better suited for this role because they are more liquid - more likely to be accepted in trade - even if they have a lower return. The reason assets are more or less likely to be accepted is modeled using informational frictions, or recognizability. While everyone understands e.g. what currency is and what it is worth, some might be less sure about other claims. In our model, agents who do not recognize assets do not accept them in trade. Recognizability is endogenized by letting agents invest in information, potentially generating multiple equilibria with different liquidity. We discuss implications for asset pricing and for monetary policy. In particular, we show explicitly that what may look like a cash-in-advance constraint is not invariant to policy interventions or other changes in the economic environment

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File URL: http://economics.sas.upenn.edu/system/files/working-papers/08-039.pdf
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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 08-039.

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Length: 36 pages
Date of creation: 15 Oct 2008
Date of revision:
Handle: RePEc:pen:papers:08-039
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