NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
loading...

Monetary Exchange in Over-the-Counter Markets: A Theory of Speculative Bubbles, the Fed Model, and Self-fulfilling Liquidity Crises

Ricardo Lagos, Shengxing Zhang

NBER Working Paper No. 21528
Issued in September 2015
NBER Program(s):The Asset Pricing Program, The Monetary Economics Program

We develop a model of monetary exchange in over-the-counter markets to study the effects of monetary policy on asset prices and standard measures of financial liquidity, such as bid-ask spreads, trade volume, and the incentives of dealers to supply immediacy, both by participating in the market-making activity and by holding asset inventories on their own account. The theory predicts that asset prices carry a speculative premium that reflects the asset's marketability and depends on monetary policy as well as the microstructure of the market where it is traded. These liquidity considerations imply a positive correlation between the real yield on stocks and the nominal yield on Treasury bonds---an empirical observation long regarded anomalous. The theory also exhibits rational expectations equilibria with recurring belief driven events that resemble liquidity crises, i.e., times of sharp persistent declines in asset prices, trade volume, and dealer participation in market-making activity, accompanied by large increases in spreads and abnormally long trading delays.

download in pdf format
   (1712 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w21528

Users who downloaded this paper also downloaded* these:
Ireland w21576 Monetary Policy, Bond Risk Premia, and the Economy
Jordà, Schularick, and Taylor w21486 Leveraged Bubbles
Abel w21549 The Analytics of Investment, q, and Cash Flow
García-Schmidt and Woodford w21614 Are Low Interest Rates Deflationary? A Paradox of Perfect-Foresight Analysis
Farhi and Gabaix w21524 Optimal Taxation with Behavioral Agents
 
Publications
Activities
Meetings
NBER Videos
Themes
Data
People
About

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us