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Search-based endogenous asset liquidity and the macroeconomy

Author

Listed:
  • Radde, Sören
  • Cui, Wei
Abstract
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 Classification: E22, E44, G11

Suggested Citation

  • Radde, Sören & Cui, Wei, 2016. "Search-based endogenous asset liquidity and the macroeconomy," Working Paper Series 1917, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20161917
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    More about this item

    Keywords

    asset search markets; endogenous asset liquidity; financial shocks; financing constraints; liquidity premium;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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