Free-riding on liquidity
Do financial market participants free-ride on liquidity? To address this question, we construct a dynamic general equilibrium model where agents face idiosyncratic preference and technology shocks. A secondary financial market allows agents to adjust their portfolio of liquid and illiquid assets in response to these shocks. The opportunity to do so reduces the demand for the liquid asset and, hence, its value. The optimal policy response is to restrict (but not eliminate) access to the secondary financial market. The reason for this result is that the portfolio choice exhibits a pecuniary externality: An agent does not take into account that by holding more of the liquid asset, he not only acquires additional insurance but also marginally increases the value of the liquid asset which improves insurance to other market participants.
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- Berentsen, Aleksander & Waller, Christopher, 2011.
"Outside versus inside bonds: A ModiglianiâMiller type result for liquidity constrained economies,"
Journal of Economic Theory,
Elsevier, vol. 146(5), pages 1852-1887, September.
- Aleksander Berentsen & Christopher Waller, 2009. "Outside versus inside bonds: A Modigliani-Miller type result for liquidity constrained economies," IEW - Working Papers 443, Institute for Empirical Research in Economics - University of Zurich.
- Aleksander Berentsen & Christopher Waller, 2010. "Outside versus Inside Bonds: A Modigliani-Miller Type Result for Liquidity Constrained Economies," CESifo Working Paper Series 3272, CESifo Group Munich.
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123456789/7353, Paris Dauphine University.
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"Money, Credit, and Banking,"
2004 Meeting Papers
473, Society for Economic Dynamics.
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