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Money, Payments, and Liquidity$
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Ed Nosal and Guillaume Rocheteau

Print publication date: 2011

Print ISBN-13: 9780262016285

Published to MIT Press Scholarship Online: August 2013

DOI: 10.7551/mitpress/9780262016285.001.0001

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Liquidity and Trading Frictions

Liquidity and Trading Frictions

(p.317) 12 Liquidity and Trading Frictions
Money, Payments, and Liquidity

Ed Nosal

Guillaume Rocheteau

The MIT Press

This chapter expounds on the notion of the liquidity of an asset and its ability to function as a medium of exchange. Here, trading frictions are not associated with the purchase and consumption of goods. Instead, these are introduced into an asset market, or an over-the-counter market, with bilateral matches between investors and dealers. This model is further explored in an economy where investors accumulate capital goods to produce a general consumption good. Trading fictions are also endogenized by accepting free entry of dealers in the market-making sector. The chapter shows that multiple equilibria is reached due to the presence of complementarities between investors’ asset-holding decisions and dealers’ entry decisions, leading to the drying up of liquidity in the market because of self-fulfilling beliefs.

Keywords:   liquidity of an asset, medium of exchange, trading frictions, asset market, over-the-counter market, bilateral matches, multiple equilibria

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