Frictional Asset Reallocation under Adverse Selection

University of Zurich, Department of Economics, Working Paper No. 261, Revised version

44 Pages Posted: 29 Sep 2017 Last revised: 26 Jan 2018

Date Written: January 24, 2018

Abstract

The aim of this paper is to study asset reallocation in financial markets subject to search, bargaining, and information frictions, and to analyze the impact of monetary policy on equilibrium outcomes. The main results show that private information regarding the quality of an asset impairs its liquidity and reduces both trading volume and consumption. As a consequence, a positive liquidity differential between money and real assets emerges, resulting in an increased demand for fiat money, as observed since the eruption of the global financial crisis. A policy intervention replacing information sensitive assets with government bonds or fiat money, as done in the asset-purchase program implemented by the Federal Reserve Bank, improves welfare.

Keywords: Money, assets, search and matching, asymmetric information, signaling, undefeated equilibrium

JEL Classification: D82, D83, E44, E52, G11, G12

Suggested Citation

Madison, Florian, Frictional Asset Reallocation under Adverse Selection (January 24, 2018). University of Zurich, Department of Economics, Working Paper No. 261, Revised version. Available at SSRN: https://ssrn.com/abstract=3042479 or http://dx.doi.org/10.2139/ssrn.3042479

Florian Madison (Contact Author)

University of Basel ( email )

Petersplatz 1
Basel, CH-4003
Switzerland

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