Cash-in-the-Market Pricing in a Model with Money and Over-the-Counter Financial Markets

36 Pages Posted: 15 Dec 2013

See all articles by Fabrizio Mattesini

Fabrizio Mattesini

University of Rome Tor Vergata - Faculty of Economics

Ed Nosal

Federal Reserve Banks - Federal Reserve Bank of Atlanta

Date Written: November 29, 2013

Abstract

Entrepreneurs need cash to finance their real investments. Since cash is costly to hold, entrepreneurs will underinvest. If entrepreneurs can access financial markets prior to learning about an investment opportunity, they can sell some of their less liquid assets for cash and, as a result, invest at a higher level. When financial markets are over-the-counter, the price that the entrepreneur receives for the assets that he sells depends on the amount of liquidity (cash) that is in the OTC market: Greater levels of liquidity lead to higher asset prices. Since asset prices are linked to liquidity, they can fluctuate over time even though asset fundamentals are fixed. Bid and ask prices naturally arise in an OTC market and the bid-ask spread is negatively correlated with asset returns when changes in asset prices are not related to changes in the OTC market structure. An increase in inflation widens bid-ask spreads and decreases asset prices.

Keywords: Money and Interest Rates: General, Asset Pricing, Trading volume, Bond Interest Rates

JEL Classification: E4, G12

Suggested Citation

Mattesini, Fabrizio and Nosal, Ed, Cash-in-the-Market Pricing in a Model with Money and Over-the-Counter Financial Markets (November 29, 2013). FRB of Chicago Working Paper No. 2013-24. Available at SSRN: https://ssrn.com/abstract=2367459 or http://dx.doi.org/10.2139/ssrn.2367459

Fabrizio Mattesini

University of Rome Tor Vergata - Faculty of Economics ( email )

Via Columbia n.2
Rome, rome 00100
Italy

Ed Nosal (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

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