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Money, Asset Prices and the Liquidity Premium

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  • Lee, Seungduck

Abstract

This paper examines the effect of monetary policy on the liquidity premium, i.e., the market value of the liquidity services that financial assets provide. To guide the empirical analysis, I set up a monetary search model in which bonds provide liquidity services in addition to money. The theory predicts that money supply and the nominal interest rate are positively correlated with the liquidity premium, but the latter is negatively correlated with the bond supply. The empirical analysis over the period from 1946 and 2008 confirms the theoretical findings. This indicates that liquid bonds are substantive substitutes for money and the opportunity cost of holding money plays a key role in asset price determination. The model can rationalize the existence of negative nominal yields, when the nominal interest rate is low and liquid bond supply decreases.

Suggested Citation

  • Lee, Seungduck, 2016. "Money, Asset Prices and the Liquidity Premium," MPRA Paper 74010, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:74010
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    References listed on IDEAS

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    1. Geromichalos, Athanasios & Simonovska, Ina, 2014. "Asset liquidity and international portfolio choice," Journal of Economic Theory, Elsevier, vol. 151(C), pages 342-380.
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    5. Geromichalos, Athanasios & Herrenbrueck, Lucas M. & Salyer, Kevin D., 2016. "A search-theoretic model of the term premium," Theoretical Economics, Econometric Society, vol. 11(3), September.
    6. Athanasios Geromichalos & Jiwon Lee & Seungduck Lee & Keita Oikawa, 2016. "Over-the-counter trade and the value of assets as collateral," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 62(3), pages 443-475, August.
    7. Jacquet, Nicolas L. & Tan, Serene, 2012. "Money and asset prices with uninsurable risks," Journal of Monetary Economics, Elsevier, vol. 59(8), pages 784-797.
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    11. Aruoba, S. Boragan & Waller, Christopher J. & Wright, Randall, 2011. "Money and capital," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 98-116, March.
    12. Jung, Kuk Mo & Lee, Seungduck, 2015. "A Liquidity-Based Resolution of the Uncovered Interest Parity Puzzle," MPRA Paper 64164, University Library of Munich, Germany.
    13. Benjamin Lester & Andrew Postlewaite & Randall Wright, 2012. "Information, Liquidity, Asset Prices, and Monetary Policy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(3), pages 1209-1238.
    14. Geromichalos, Athanasios & Herrenbrueck, Lucas M. & Salyer, Kevin D., 2016. "A search-theoretic model of the term premium," Theoretical Economics, Econometric Society, vol. 11(3), September.
    15. Lucas, Robert E. & Nicolini, Juan Pablo, 2015. "On the stability of money demand," Journal of Monetary Economics, Elsevier, vol. 73(C), pages 48-65.
    16. Alessandro Beber & Michael W. Brandt & Kenneth A. Kavajecz, 2009. "Flight-to-Quality or Flight-to-Liquidity? Evidence from the Euro-Area Bond Market," The Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 925-957.
    17. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
    18. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
    19. Stefan Nagel, 2016. "The Liquidity Premium of Near-Money Assets," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 131(4), pages 1927-1971.
    20. Stephen D. Williamson, 2012. "Liquidity, Monetary Policy, and the Financial Crisis: A New Monetarist Approach," American Economic Review, American Economic Association, vol. 102(6), pages 2570-2605, October.
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    Cited by:

    1. Seungduck Lee & Kuk Mo Jung, 2019. "A Liquidity-Based Resolution of the Uncovered Interest Parity Puzzle," Working Papers 1902, Nam Duck-Woo Economic Research Institute, Sogang University (Former Research Institute for Market Economy).
    2. Heon Lee, 2021. "Money Creation and Banking: Theory and Evidence," Papers 2109.15096, arXiv.org, revised Jun 2024.

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    More about this item

    Keywords

    asset price; money search model; liquidity; liquidity premium; money supply;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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