Monetary policy and efficiency in over‐the‐counter financial trade

Abstract

We develop a monetary model that incorporates over-the-counter (OTC) asset trade. After agents have made their money holding decisions, they receive an idiosyncratic shock that affects their valuation for consumption and, hence, for the unique liquid asset, namely money. Subsequently, agents can choose whether they want to enter the OTC market in order to sell assets and thus boost their liquidity or to buy assets and thus provide liquidity to other agents. In our model, inflation affects not only the money holding decisions of agents, as is standard in monetary theory, but also the entry decision of these agents in the financial market. We use our framework to study the effect of inflation on welfare, asset prices and OTC trade volume. In contrast to most monetary models, which predict a negative relationship between inflation and welfare, we find that inflation can be welfare improving within a certain range, because it mitigates a search externality that agents impose on one another when they make their OTC market entry decision. Also, an increase in the holding cost of money will lead to a decrease in asset prices, a regularity that is well documented in the data and often considered anomalous.Résumé. Politique monétaire et efficacité sur le marché financier de gré à gré. Dans cet article, nous développons un modèle monétaire intégrant la vente d'actifs négociés de gré à gré. Après encaisse, les agents subissent un choc idiosyncratique qui affecte leur appétence pour la consommation et donc pour les actifs liquides, autrement dit l'argent. Consécutivement, les agents peuvent soit décider d'accéder au marché hors cote pour vendre des actifs afin d'accroître leurs liquidités, soit d'acheter des actifs pour fournir des liquidités aux autres agents. Dans notre modèle, et conformément à la théorie monétaire, l'inflation n'affecte pas seulement les décisions des agents en matière d'encaisse, mais aussi leur décision d'accéder au marché financier. Nous utilisons notre propre cadre pour étudier les effets de l'inflation sur le bien-être, le prix des actifs et le volume des échanges négociés hors marché. Les modèles monétaires établissent pour la plupart une relation négative entre l'inflation et le niveau de bien-être; néanmoins, et contrairement à ces modèles, nous avons découvert que l'inflation pouvait améliorer le niveau de bien-être en réduisant la recherche d'externalité que s'imposent les agents entre eux lorsqu'ils intègrent le marché de gré à gré. De même, l'augmentation des coûts liés à la détention Corresponding author: Kuk Mo Jung, kmjung@sogang.ac.krWe would like to thank the editor, Francisco Ruge-Murcia and two anonymous referees for their useful comments and suggestions. The authors did not receive financial support related to this project from any institution.

Asset liquidity and indivisibility

“…Therefore, under bargaining and indivisible goods, when a buyer brings a medium of exchange into the DM, he is able to extract all the surplus from trade. 6 Using proportional bargaining, i.e., Kalai and Smorodinsky (1975), for terms of trade yields the same results. 7 Using = 1=(1 + r), rewrite the spread equation as 1 + s t = (1 + r)' t =(' t+1 + ).…”

“…] is a potential bargaining solution. 6 Substituting V b t+1 into W b t and a buyer's CM value function is…”

An Over‐the‐counter Approach to the Forex Market

“…Their paper focuses on the impact of intermediation on asset mobility, whereas ours focuses on how intermediation affects certain liquidity measures in the FOREX market. Geromichalos and Herrenbrueck () and Geromichalos and Jung () consider models where agents can allocate their wealth between money and an illiquid asset, and, following an idiosyncratic consumption shock, they can acquire additional liquidity in an OTC financial market. This article has similar structure since agents who get an opportunity to consume abroad can acquire foreign currency in the OTC FOREX market.…”