Liquidity and Asset Prices

Raphael A. Espinoza and Dimitrios Tsomocos

No 2008fe28, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: We show in an exchange economy with liquidity constraints that the volume of trade and asset prices depend on both the supply of liquidity by the Central Bank and on the liquidity of assets and commodities. As a result, monetary aggregates are informative for the assessment of economic developments and the conduct of monetary policy. We also show that the positive correlation between state prices and the future spot rate generates a risk-premium in the term structure of interest rates, even in absence of aggregate uncertainty. These results do not obtain in representative agent models but hold in any monetary economy with heterogeneous agents and short-term liquidity effects, where monetary costs act as transaction costs and the quantity theory of money is verified.

Keywords: Liquidity; Cash-in-Advance Constraints; Term Structure of Interest Rates (search for similar items in EconPapers)
JEL-codes: E43 G12 (search for similar items in EconPapers)
Date: 2008-07-01
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Citations: View citations in EconPapers (1)

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