A Monetary Approach to Asset Liquidity

Rocheteau, Guillaume

doi:10.26509/frbc-wp-200901

Cited by 32 publications

(42 citation statements)

References 67 publications

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“…2 When assets are opaque, private information can arise when owners of assets have an advantage or a higher incentive to acquire information about the quality of assets relative to potential buyers (see Dang, Gorton and Holmstrom, 2009). 3 Another related literature uses random matching models with private information to study monetary exchange (for example Williamson and Wright, 1994;Lester, Postlewaite and Wright, 2008;Rocheteau, 2009; Our paper shows that shocks to asset quality lead to a market freeze due to a lemons problem a la Akerlof (1970) when traders have to search for a counterparty. Trading, however, can be restored, if the government reduces the adverse selection problem (Mankiw, 1986).…”

Section: Introductionmentioning

confidence: 99%

Trading Dynamics with Adverse Selection and Search: Market Freeze, Intervention and Recovery

Chiu¹,

Koeppl²

2016

Review of Economic Studies

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We study the trading dynamics in an asset market where the quality of assets is private information of the owner and finding a counterparty takes time. When trading of a financial asset ceases in equilibrium as a response to an adverse shock to asset quality, a large player can resurrect the market by buying up lemons which involves assuming financial losses. The equilibrium response to such a policy is intricate as it creates an announcement effect: a mere announcement of intervening at a later point in time can cause markets to function again. This effect leads to a gradual recovery in trading volume, with asset prices converging non-monotonically to their normal values. The optimal policy is to intervene immediately with minimal size when markets are deemed important and losses are small. As losses increase and the importance of the market declines, the optimal intervention is delayed and it can be desirable to rely more on the announcement effect by increasing the size of the intervention. Search frictions are important for all these results. They compound adverse selection, making a market more fragile with respect to a classic lemons problem. They dampen the announcement effect and cause the optimal policy to be more aggressive, leading to an earlier intervention at a larger scale. JEL classification: G1, E6 Bank classification: Financial markets; Financial stability RésuméLes auteurs étudient la dynamique des échanges sur un marché où la qualité des actifs est une information privée détenue par les propriétaires et où la recherche d'une contrepartie demande du temps. Lorsque, à l'équilibre, les actifs financiers ne sont plus échangés par suite d'un choc entraînant une dégradation de leur qualité, l'intervention d'un participant de grande stature, qui est prêt à acheter des actifs de mauvaise qualité et, donc, à supporter des pertes financières, peut relancer les échanges. Cette intervention donne lieu à un équilibre complexe car elle produit un effet d'annonce : le seul fait d'annoncer une intervention à venir peut amener les marchés à fonctionner de nouveau. Cet effet entraîne une reprise graduelle du volume d'échanges, les prix convergeant de façon non monotone à leurs valeurs normales. La politique optimale consiste à intervenir immédiatement par l'acquisition d'un volume minimal d'actifs pendant que le marché est jugé important et que les pertes sont minces. Lorsque les pertes grossissent et que l'importance du marché décline, il devient optimal d'intervenir plus tardivement, et il peut alors être préférable de compter davantage sur l'effet d'annonce en haussant la taille des achats escomptés. Les frictions concernant la prospection comptent dans tous ces résultats. Elles amplifient l'antisélection, rendant le marché plus vulnérable aux difficultés que crée généralement la présence d'actifs de piètre qualité. Elles atténuent l'effet d'annonce et requièrent une politique optimale plus ambitieuse, c'est-à-dire une intervention précoce à plus grande échelle.

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Section: Introductionmentioning

confidence: 99%

Trading Dynamics with Adverse Selection and Search: Market Freeze, Intervention and Recovery

Chiu¹,

Koeppl²

2016

Review of Economic Studies

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“…In this version of the model, if households have too much bargaining power then it is optimal keep liquidity scarce. More work could be done on these 1 3 For related results showing how optimal policy can depend on the mechanism, see Rocheteau andWright (2005,2009). …”

Section: Public Liquidity Provisionmentioning

confidence: 99%

“…In fact, it is straightforward to allow credit in some meetings, but not others, and all results go through exactly as stated provided we reinterpret as the probability of a nocredit meeting. Similarly, we can assume shares in …rms are recognizable in some meetings, but not others, or make counterfeiting costly and use the endogenous upper bound s > 0 derived in Rocheteau (2008) or Li and Rocheteau (2009) (recall that s = 0 when counterfeiting is costless). Given this is understood, we proceed here with d t = s = 0 in all DM meetings.…”

Section: Imperfect Creditmentioning

confidence: 99%

Liquidity and Asset Market Dynamics

Rocheteau¹,

Wright²

2010

Working Paper (Federal Reserve Bank of Cleveland)

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“…Also, because we want to have both money and equity used in transactions, even when money is dominated in rate of return, we give shares a disadvantage in terms of recognizability. Thus buyers in the DM can costlessly produce fake shares, which are illegitimate claims to dividends in the CM, perhaps because they are counterfeit-bad claims to good trees-or because they are lemonsgood claims to bad trees (see Rocheteau, 2009;and Li and Rocheteau, 2010, for more on this).…”

Section: Asset Pricing and Liquiditymentioning

confidence: 99%

New Monetarist Economics: Methods

Williamson¹,

Wright²

2010

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A Monetary Approach to Asset Liquidity

Cited by 32 publications

References 67 publications

Trading Dynamics with Adverse Selection and Search: Market Freeze, Intervention and Recovery

Trading Dynamics with Adverse Selection and Search: Market Freeze, Intervention and Recovery

Liquidity and Asset Market Dynamics

New Monetarist Economics: Methods

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