Search Results
Discussion Paper
A conference on liquidity in frictional markets
This Policy Discussion Paper summarizes the papers that were presented at the Liquidity in Frictional Markets conference in November 2008. The papers, which looked at markets for assets as diverse as houses, bank loans, and electronic funds transfer, all explored that amorphous concept called liquidity and how its presenceor absenceaffects the economy.
Working Paper
A Tractable Model of Monetary Exchange with Ex-Post Heterogeneity
We construct a continuous-time, New-Monetarist economy with general preferences that displays an endogenous, non-degenerate distribution of money holdings. Properties of equilibria are obtained analytically and equilibria are solved in closed form in a variety of cases. We study policy as incentive-compatible transfers financed with money creation. Lump-sum transfers are welfare-enhancing when labor productivity is low, but regressive transfers achieve higher welfare when labor productivity is high. We introduce illiquid government bonds and draw implications for the existence of ...
Working Paper
Heterogeneity in Decentralized Asset Markets
We study a search and bargaining model of asset markets in which investors? heterogeneous valuations for the asset are drawn from an arbitrary distribution. We present a solution technique that makes the model fully tractable, and allows us to provide a complete characterization of the unique equilibrium, in closed form, both in and out of steady state. Using this characterization, we derive several novel implications that highlight the importance of heterogeneity. In particular, we show how some investors endogenously emerge as intermediaries, even though they have no advantage in contacting ...
Working Paper
Frictional Intermediation in Over-the-Counter Markets
We extend Duffie, G?arleanu, and Pedersen?s (2005) search theoretic model of over-the-counter (OTC) asset markets, allowing for a decentralized inter-dealer market with arbitrary heterogeneity in dealers? valuations or inventory costs. We develop a solution technique that makes the model fully tractable and allows us to derive, in closed form, theoretical formulas for key statistics analyzed in empirical studies of the intermediation process in OTC markets. A calibration to the market for municipal securities reveals that the model can generate trading patterns and prices that are ...
Working Paper
Competing for order flow in OTC markets
The authors develop a model of a two-sided asset market in which trades are intermediated by dealers and are bilateral. Dealers compete to attract order flow by posting the terms at which they execute trades, which can include prices, quantities, and execution times, and investors direct their orders toward dealers that offer the most attractive terms of trade. Equilibrium outcomes have the following properties. First, investors face a trade-off between trading costs and speeds of execution. Second, the asset market is endogenously segmented in the sense that investors with different asset ...
Report
The market for OTC derivatives
We develop a model of equilibrium entry, trade, and price formation in over-the-counter (OTC) markets. Banks trade derivatives to share an aggregate risk subject to two trading frictions: they must pay a fixed entry cost, and they must limit the size of the positions taken by their traders because of risk-management concerns. Although all banks in our model are endowed with access to the same trading technology, some large banks endogenously arise as ?dealers,? trading mainly to provide intermediation services, while medium sized banks endogenously participate as ?customers? mainly to share ...
Working Paper
Liquidity in frictional asset markets
On November 14-15, 2008, the Federal Reserve Bank of Cleveland hosted a conference on ?Liquidity in Frictional Asset Markets.? In this paper we review the literature on asset markets with trading frictions in both finance and monetary theory using a simple search-theoretic model, and we discuss the papers presented at the conference in the context of this literature. We will show the diversity of topics covered in this literature, e.g., the dynamics of housing and credit markets, the functioning of payment systems, optimal monetary policy and the cost of inflation, the role of banks, the ...
Working Paper
Heterogeneity in decentralized asset markets
We study a search and bargaining model of an asset market, where investors? heterogeneous valuations for the asset are drawn from an arbitrary distribution. Our solution technique renders the analysis fully tractable and allows us to provide a full characterization of the equilibrium, in closed-form, both in and out of steady-state. We use this characterization for two purposes. First, we establish that the model can naturally account for a number of stylized facts that have been documented in empirical studies of over-the-counter asset markets. In particular, we show that heterogeneity among ...
Report
Measuring the financial soundness of U.S. firms, 1926-2012
Building on the Merton (1974) and Leland (1994) structural models of credit risk, we develop a simple, transparent, and robust method for measuring the financial soundness of individual firms using data on their equity volatility. We use this method to retrace quantitatively the history of firms? financial soundness during U.S. business cycles over most of the last century. We highlight three main findings. First, the three worst recessions between 1926 and 2012 coincided with insolvency crises, but other recessions did not. Second, fluctuations in asset volatility appear to drive variation ...
Working Paper
Liquidity and the threat of fraudulent assets
We study an over-the-counter (OTC) market with bilateral meetings and bargaining where the usefulness of assets, as means of payment or collateral, is limited by the threat of fraudulent practices. We assume that agents can produce fraudulent assets at a positive cost, which generates endogenous upper bounds on the quantity of each asset that can be sold, or posted as collateral in the OTC market. Each endogenous, asset-specific, resalability constraint depends on the vulnerability of the asset to fraud, on the frequency of trade, and on the current and future prices of the asset. In ...