Balance Sheet Recessions with Informational and Trading Frictions

Vladimir Asriyan

No 806, Working Papers from Barcelona School of Economics

Abstract: We consider a model of the balance sheet channel à la Kiyotaki and Moore (1997) but allow agents to trade claims contingent on aggregate states. We show that the interaction of information dispersion about aggregate states with trading frictions in secondary claims markets generates mispricing of aggregate risk, distorts the demand for state-contingent claims and limits aggregate risk-sharing, thereby giving rise to the balance sheet channel. The magnitude of aggregate fluctuations becomes tied to the severity of information-trading frictions and, as they vanish, the balance sheet channel disappears. Thus, the model suggests that the functioning of secondary claims markets has important implications for business cycles. Importantly, the laissez-faire equilibrium is constrained inefficient because information-trading frictions generate rent-extraction in secondary claims markets. Optimal policy targets the inefficiency at its source by promoting both issuance and trade of state-contingent claims in markets.

Keywords: liquidity; balance sheet recessions; contingent contracts; informational frictions; trading frictions; financial regulation (search for similar items in EconPapers)
JEL-codes: E32 E44 G01 (search for similar items in EconPapers)
Date: 2015-09
New Economics Papers: this item is included in nep-dge, nep-ias and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Working Paper: Balance sheet recessions with information and trading frictions (2018)
Working Paper: Balance sheet recessions with informational and trading frictions (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:bge:wpaper:806

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