Search-Based Endogenous Illiquidity and the Macroeconomy

By Wei Cui and Sören Radde

http://d.repec.org/n?u=RePEc:diw:diwwpp:dp1367&r=dge

We endogenize asset liquidity in a dynamic general equilibrium model with search frictions on asset markets. In the model, asset liquidity is tantamount to the ease of issuance and resaleability of private financial claims, which is driven by investors’ participation on the search market. Limited resaleability of private claims creates a role for liquid assets, such as government bonds or fiat money, to ease funding constraints. We show that liquidity and asset prices positively co-move. When the capacity of the asset market to channel funds to entrepreneurs deteriorates, the hedging value of liquid assets increases. Our model is thus able to match the flight to liquidity observed during recessions. Finally, we show that investors’ search market participation is more intense in a constrained efficient economy.

From the latest NEP-DGE report, I have selected this paper because I did not know it was possible to obtain endogenous asset liquidity. Money search has shown us that demand for a very liquid asset can emerge, but it is only a dichotomous choice. In this paper, The liquid asset is always present, and the demand for the illiquid one varies, and as the market for theses illiquid ones is modeled as a search process, its liquidity depends on market participation. Liquidity is thus endogenous, and it matters.

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