TY - JOUR AU - Bolton,Patrick AU - Santos,Tano AU - Scheinkman,Jose A. TI - Outside and Inside Liquidity JF - National Bureau of Economic Research Working Paper Series VL - No. 14867 PY - 2009 Y2 - April 2009 UR - http://www.nber.org/papers/w14867 L1 - http://www.nber.org/papers/w14867.pdf N1 - Author contact info: Patrick Bolton Columbia Business School 804 Uris Hall New York, NY 10027 Tel: 212/854-9245 Fax: 212/854-8059 E-Mail: pb2208@columbia.edu Tano Santos Graduate School of Business Columbia University 3022 Broadway, Uris Hall 414 New York, NY 10027 Tel: 212/854-0489 Fax: 212/316-9180 E-Mail: js1786@columbia.edu Jose A. Scheinkman Department of Economics Princeton University Princeton, NJ 08544-1021 Tel: 609/258-4020 Fax: 609/258-0771 E-Mail: joses@princeton.edu AB - We consider a model of liquidity demand arising from a possible maturity mismatch between asset revenues and consumption. This liquidity demand can be met with either cash reserves (inside liquidity) or via asset sales for cash (outside liquidity). The question we address is, what determines the mix of inside and outside liquidity in equilibrium? An important source of inefficiency in our model is the presence of asymmetric information about asset values, which increases the longer a liquidity trade is delayed. We establish existence of an immediate-trading equilibrium, in which asset trading occurs in anticipation of a liquidity shock, and sometimes also of a delayed-trading equilibrium, in which assets are traded in response to a liquidity shock. We show that, when it exists, the delayed-trading equilibrium is Pareto superior to the immediate-trading equilibrium, despite the presence of adverse selection. However, the presence of adverse selection may inefficiently accelerate asset liquidation. We also show that the delayed-trading equilibrium features more outside liquidity than the immediate-trading equilibrium although it is supplied in the presence of adverse selection. Finally, long term contracts do not always dominate the market provision of liquidity. ER -