TY  - JOUR
AU  - Lagos,Ricardo
AU  - Rocheteau,Guillaume
AU  - Weill,Pierre-Olivier
TI  - Crises and Liquidity in Over-the-Counter Markets
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 15414
PY  - 2009
Y2  - October 2009
UR  - http://www.nber.org/papers/w15414
L1  - http://www.nber.org/papers/w15414.pdf
N1  - Author contact info:
Ricardo Lagos
Department of Economics
New York University
19 West Fourth Street
New York, NY 10014
Tel: 212/998-8937
E-Mail: ricardo.lagos@nyu.edu

Guillaume Rocheteau
Department of Economics
University of California at Irvine
3151 Social Science Plaza
Irvine, California 9269
E-Mail: grochete@uci.edu

Pierre-Olivier Weill
Department of Economics
University of California, Los Angeles
Bunche Hall 8283
Los Angeles, CA 90095
Tel: 310/794-6495
Fax: 310/825-9528
E-Mail: poweill@econ.ucla.edu
AB  - We study the efficiency of dealers’ liquidity provision and the desirability of policy intervention in over-the-counter (OTC) markets during crises. Our theory emphasizes two key frictions in OTC markets: finding counterparties takes time, and trade is bilateral, with quantities and prices determined by bargaining. We model a crisis as a negative shock to investors’ asset demands that lasts until a random recovery time. In this context, dealers can provide liquidity to outside investors by acting as counterparties in trades and by accumulating asset inventories. We find that, when frictions are severe, even well capitalized dealers may not find it optimal to accumulate inventories, given that investors choose asset positions that require small reallocations. In such circumstances, the market allocative efficiency can increase if the government steps in, purchases private assets on its own account, and resells them when the economy recovers.
ER  -