Toxic Assets and Market Freezes

Chao Gu, Guido Menzio, Randall Wright and Yu Zhu

No 2001, Working Papers from Department of Economics, University of Missouri

Abstract: We study economies where some assets are toxic –i.e., they have negative returns –but still have positive prices because they provide liquidity as payment instruments or as collateral. Even without changes in fundamentals markets can, as a self-fulfi…lling prophecy, freeze and thaw recurrently: toxic assets stop trading for a spell, then restart. We show markets without toxic assets might have hot and cold spells, where prices and quantities ‡fluctuate, but cannot freeze and thaw (at least without nonconvexities). Freezes can occur when there are toxic assets plus fi…at currency, and whether these assets trade for goods or trade for money.

Keywords: toxic assets; market freezes; negative returns; liquidity (search for similar items in EconPapers)
JEL-codes: D53 D83 E30 E44 E52 G14 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2020-03-10
New Economics Papers: this item is included in nep-mac and nep-ore
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