Liquidity Sentiments

The American Economic Review, Forthcoming

41 Pages Posted: 18 Jan 2018 Last revised: 11 Jul 2019

See all articles by Vladimir Asriyan

Vladimir Asriyan

CREI; Barcelona GSE; Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR)

William Fuchs

University of Texas at Austin - Department of Finance; Universidad Carlos III de Madrid - Department of Economics

Brett Green

Washington University in St. Louis - John M. Olin Business School

Date Written: June 18, 2019

Abstract

We develop a rational theory of liquidity sentiments in which the market outcome in any given period depends on agents’ expectations about market conditions in future periods. Our theory is based on the interaction between adverse selection and resale considerations giving rise to an intertemporal coordination problem that yields multiple self-fulfilling equilibria. We construct “sentiment” equilibria in which sunspots generate fluctuations in prices, volume, and welfare, all of which are positively correlated. The intertemporal nature of the coordination problem disciplines the set of possible sentiment dynamics. In particular, sentiments must be sufficiently persistent and transitions must be stochastic. We con- sider an extension with production in which asset quality is endogenously determined and provide conditions under which sentiments are a necessary feature of any equilibrium. A testable implication is that assets produced in good times are of lower average quality than those produced in bad times.

Keywords: Sentiment; Liquidity; Asset Prices; Capital Reallocation; Business Cycles; Sunspots

JEL Classification: D82; E32; E44; G12

Suggested Citation

Asriyan, Vladimir and Fuchs, William Martin and Green, Brett, Liquidity Sentiments (June 18, 2019). The American Economic Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3100751 or http://dx.doi.org/10.2139/ssrn.3100751

Vladimir Asriyan (Contact Author)

CREI ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

HOME PAGE: http://crei.cat/people/asriyan/welcome.html

Barcelona GSE ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

HOME PAGE: http://www.barcelonagse.eu/Faculty.php?id=510

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, E-08005
Spain

HOME PAGE: http://www.econ.upf.edu/en/people/onefaculty.php?id=p7040

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

William Martin Fuchs

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

Universidad Carlos III de Madrid - Department of Economics ( email )

Calle Madrid 126
Getafe, 28903
Spain

Brett Green

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

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