Monetary Policy, Asset Prices, and Liquidity in Over-the-Counter Markets

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. We revisit a traditional topic in monetary economics: the relationship between asset prices and monetary policy. We study a model in which money helps facilitate trade in decentralized markets, as in Lagos andWright (2005), and real assets are traded in an over-the-counter (OTC) market, as in Duffie, Gˆarleanu, and Pedersen (2005). Agents wish to hold liquid portfolios, but liquidity comes at a cost: inflation. The OTC market serves as a secondary asset market, in which agents can rebalance their positions depending on their liquidity needs. Hence, a contribution of our paper is to provide a micro-founded explanation of the assumption that different investors have different valuations for the same asset, which is the key for generating gains from trade in the Duffie et al framework. In equilibrium, assets can be priced higher than their fundamental value because they help agents avoid the inflation tax. Terms of use: Documents in Department of EconomicsOne Shields Avenue Davis, CA 95616 (530)752-0741 http://www.econ.ucdavis.edu/working_search.cfm Monetary Policy, Asset Prices, and Liquidity in Over-the-Counter Markets Athanasios GeromichalosUniversity of California -Davis Lucas Herrenbrueck University of California -DavisThis Version: September 2012 PRELIMINARY AND INCOMPLETE -PLEASE DO NOT CIRCULATE ABSTRACT ------------------------------------We revisit a traditional topic in monetary economics: the relationship between asset prices and monetary policy. We study a model in which money helps facilitate trade in decentralized markets, as in Lagos and Wright (2005), and real assets are traded in an over-the-counter (OTC) market, as in Duffie, Gârleanu, and Pedersen (2005). Agents wish to hold liquid portfolios, but liquidity comes at a cost: inflation. The OTC market serves as a secondary asset market, in which agents can rebalance their positions depending on their liquidity needs. Hence, a contribution of our paper is to provide a micro-founded explanation of the assumption that different investors have different valuations for the same asset, which is the key for generating gains from trade in the Duffie et al framework. In equilibrium, assets can be priced higher than their fundamental value because they help agents avoid the inflation tax.Keywords: monetary-search models, liquidity, asset prices, over-the-counter markets Email: ageromich@ucdavis.edu, herrenbrueck@ucdavis.edu.We are grateful to Jonathan Chiu, Miguel Molico, Guillaume Rocheteau, Christo...

Central Bank Purchases of Government Bonds

“…From Lemma 8 it follows that for u (q) = q 1 =(1 ), we need 2 (0; 1) and 2 to have an overlapping region supporting the type-II and the type-III equilibrium for all > 12 . 15 Otherwise, by Lemma 10, there exists a region which does not support trading in the secondary …nancial market for > 12 . For the matching technology in the secondary bond market, we follow related studies and choose M(n; 1 n) = n(1 n), which implies = n and p = 1 n. The following parameters need to be identi…ed: (i) preference parameters: ( ; A; ); (ii) the technology parameter: (n); (iii) bargaining power: ( ); (iv) and policy parameters (B; ).…”

Centralized Trading of Corporate Bonds

“…Research that is more closer related to the present paper is the study by Geromichalos and Herrenbrueck (2015), who also integrate an over-the-counter market in the spirit of Duffie et al (2005) into a New Monetarist framework. 7 The authors find that for secondary financial markets which do not exhibit any search frictions, i.e., where everybody is able to trade, bargaining achieves a superior outcome to that of centralized trading.…”

A tractable model of indirect asset liquidity

“…In Geromichalos and Herrenbrueck (2012), we demonstrated that indirect asset liquidity can support many of the same conclusions, while offering an alternative microfoundation of imperfect asset substitutability: in this conception of liquidity, assets are substitutes to money because agents can sell them in a secondary financial market, and thus obtain the money needed to make a purchase. This detail is important because it implies that the structure of financial markets has first-order consequences for the 'moneyness' of different types of assets, and therefore their trading volumes and prices.…”

“…The model described here is a simplified version of Geromichalos and Herrenbrueck (2012), and we limit the exposition to the essential details. As in the framework of Lagos and Wright (2005), time is discrete and goes on forever.…”