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Wei Cui

8 June 2016
We endogenize asset liquidity in a dynamic general equilibrium model with search frictions on asset markets. In the model, asset liquidity is tantamount to the ease of issuance and resaleability of private financial claims, which is driven by investors' participation on the search market. Limited market liquidity of private claims creates a role for liquid assets, such as government bonds or at money, to ease financing constraints. We show that endogenising liquidity is essential to generate positive comovement between asset (re)saleability and asset prices. When the capacity of the asset market to channel funds to entrepreneurs deteriorates, investment falls while the hedging value of liquid assets increases, driving up liquidity premia. Our model, thus, demonstrates that shocks to the cost of financial intermediation can be an important source of flight-to-liquidity dynamics and macroeconomic fluctuations, matching key business cycle characteristics of the U.S. economy.
JEL Code
E22 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Capital, Investment, Capacity
E44 : Macroeconomics and Monetary Economics→Money and Interest Rates→Financial Markets and the Macroeconomy
G11 : Financial Economics→General Financial Markets→Portfolio Choice, Investment Decisions