Pairwise trade, asset prices, and monetary policy

“…This paper is also related to a growing literature that studies the liquidity properties of assets other than money. Examples include Geromichalos et al (2007), Lagos and Rocheteau (2008), Lagos (2011), Lester et al (2012, Nosal and Rocheteau (2013), Jacquet and Tan (2012), Andolfatto and Martin (2013), Williamson (2012), and Andolfatto et al (2014). Some recent papers exploit the idea that asset prices can carry liquidity premia to offer a new perspective for looking at longstanding asset pricing-related puzzles.…”

Section: Related Literaturementioning

confidence: 99%

A search-theoretic model of the term premium

Geromichalos

Herrenbrueck

Salyer

2016

Theoretical Economics

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A consistent empirical feature of bond yields is that term premia are, on average, positive. The majority of theoretical explanations for this observation have viewed the term premia through the lens of the consumption based capital asset pricing model. In contrast, we harken to an older empirical literature that attributes the term premium to the idea that short maturity bonds are inherently more liquid. The goal of this paper is to provide a theoretical justification of this concept. To that end, we employ a monetary‐search model extended to include assets of different maturities. Short term assets mature in time to take advantage of random consumption opportunities. Long term assets cannot be used directly to purchase consumption, but agents may liquidate them in a secondary asset market characterized by search and bargaining frictions. Our model delivers three results that are consistent with empirical facts. First, long term assets have higher rates of return in steady state to compensate agents for their relative lack of liquidity. Second, since the difference in the yield of short and long term assets reflects asset market frictions, our model predicts a steeper yield curve for assets that trade in less liquid secondary markets. Third, our model predicts that freshly issued (“on‐the‐run”) assets will sell at higher prices than previously issued (“off‐the‐run”) assets that mature in nearby dates, because sellers of the latter have a more urgent need for liquidity.

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“…So if the buyer attempts to reduce his holdings of fiat money and raise his holdings of Lucas trees to keep his total wealth constant, the optimal mechanism will reduce his surplus by a sufficiently large amount to make this deviation unprofitable. There are a few pricing mechanisms in the literature that can generate rate‐of‐return dominance outcomes (e.g., Zhu and Wallace , Nosal and Rocheteau ), but in contrast to the optimal mechanisms they do not assign all the match surplus to the buyer in equilibrium. As a result the output traded in pairwise meetings is inefficiently low…”

Section: Essential Bubblesmentioning

confidence: 99%

Monetary Policy and Asset Prices: A Mechanism Design Approach

Rocheteau

2015

J of Money Credit Banking

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We investigate the effects of monetary policy on asset prices in economies where assets are traded periodically in bilateral meetings. The trading mechanism is designed to maximize social welfare taking as given the frictions in the environment and monetary policy. We show that asset price "bubbles" emerge in a constrained-efficient monetary equilibrium only if liquidity is abundant and the first-best allocation is implementable. In contrast, if liquidity is scarce, assets are priced at their fundamental value in any constrainedefficient monetary equilibrium, in which case an increase in inflation has no effect on asset prices, but it reduces output and welfare.JEL codes: D82, D83, E40, E50

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Pairwise trade, asset prices, and monetary policy

Cited by 30 publications

References 28 publications

Turnover Liquidity and the Transmission of Monetary Policy

Turnover Liquidity and the Transmission of Monetary Policy

A search-theoretic model of the term premium

Monetary Policy and Asset Prices: A Mechanism Design Approach

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