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Liquidity Fluctuations in Over the Counter Markets

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  • Vincent Maurin

    (European University Institute)

Abstract

This paper shows that lemon markets exhibit liquidity fluctuations whereby the ease to sell an asset varies endogenously over time. In the model, agents meet in a decentralized market and bargain under asymmetry of information about the quality of the asset. Liquidity increases with the average quality of the pool of sellers but the composition of the pool responds negatively to past liquidity. When this effect is strong, cyclical equilibria arise where prices and volume of trade oscillate without aggregate shocks. These fluctuations are generally inefficient and call for policy interventions. When the economy is in a cycle, a revertible asset purchase program can jump-start the market and smooth out fluctuations. Finally, I show that increasing market centralization harms liquidity provision and may be undesirable.

Suggested Citation

  • Vincent Maurin, 2016. "Liquidity Fluctuations in Over the Counter Markets," 2016 Meeting Papers 218, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:218
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    File URL: https://economicdynamics.org/meetpapers/2016/paper_218.pdf
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    References listed on IDEAS

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    Cited by:

    1. Taneli Mäkinen & Francesco Palazzo, 2017. "The double bind of asymmetric information in over-the-counter markets," Temi di discussione (Economic working papers) 1128, Bank of Italy, Economic Research and International Relations Area.
    2. Vladimir Asriyan & William Fuchs & Brett Green, 2017. "Sentiment, liquidity and asset prices," Economics Working Papers 1583, Department of Economics and Business, Universitat Pompeu Fabra.

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