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Frictional asset reallocation under adverse selection

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  • Florian Madison

Abstract

The aim of this paper is to study asset reallocation in financial markets subject to search, bargaining, and information frictions, and to analyze the impact of monetary policy on equilibrium outcomes. The main results show that private information regarding the quality of an asset impairs its liquidity and reduces both trading volume and consumption. As a consequence, a positive liquidity differential between money and real assets emerges, resulting in an increased demand for fiat money, as observed since the eruption of the global financial crisis. A policy intervention replacing information sensitive assets with government bonds or fiat money, as done in the asset-purchase program implemented by the Federal Reserve Bank, improves welfare.

Suggested Citation

  • Florian Madison, 2017. "Frictional asset reallocation under adverse selection," ECON - Working Papers 261, Department of Economics - University of Zurich, revised Jan 2018.
  • Handle: RePEc:zur:econwp:261
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    Cited by:

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    2. Miroslav Gabrovski & Athanasios Geromichalos & Lucas Herrenbrueck & Ioannis Kospentaris & Sukjoon Lee, 2023. "The real effects of financial disruptions in a monetary economy," Working Papers 202302, University of Hawaii at Manoa, Department of Economics.
    3. Athanasios Geromichalos & Kuk Mo Jung & Seungduck Lee & Dillon Carlos, 2019. "Asset Liquidity in Monetary Theory and Finance: A Unified Approach," Working Papers 1905, Nam Duck-Woo Economic Research Institute, Sogang University (Former Research Institute for Market Economy).
    4. Wang, Zijian, 2019. "Trading Motives in Asset Markets," MPRA Paper 91401, University Library of Munich, Germany.
    5. Athanasios Geromichalos & Lucas Herrenbrueck & Sukjoon Lee, 2023. "Asset Safety versus Asset Liquidity," Journal of Political Economy, University of Chicago Press, vol. 131(5), pages 1172-1212.
    6. Wang, Chenxi, 2023. "A model of international currency with private information," Journal of International Money and Finance, Elsevier, vol. 131(C).
    7. Rocheteau, Guillaume & Wang, Lu, 2023. "Endogenous liquidity and volatility," Journal of Economic Theory, Elsevier, vol. 210(C).
    8. James B. Davies & Samantha L. Black, 2020. "Distributional Effects of Flooding, with an Application to a Major Urban Area," University of Western Ontario, Departmental Research Report Series 20201, University of Western Ontario, Department of Economics.
    9. Lee, Sukjoon, 2020. "Liquidity Premium, Credit Costs, and Optimal Monetary Policy," MPRA Paper 104825, University Library of Munich, Germany.
    10. Geromichalos, Athanasios & Jung, Kuk Mo & Lee, Seungduck & Carlos, Dillon, 2021. "A model of endogenous direct and indirect asset liquidity," European Economic Review, Elsevier, vol. 132(C).
    11. Zijian Wang, 2019. "Trading Motives in Asset Markets," University of Western Ontario, Departmental Research Report Series 20191, University of Western Ontario, Department of Economics.

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    More about this item

    Keywords

    Money; assets; search and matching; asymmetric information; signaling; undefeated equilibrium;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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