Liquidity Sentiments
Vladimir Asriyan, William Fuchs, Brett Green
American Economic Review · 2019 · Volume 109 · Issue 11
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 consider 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
Asymmetric and Private Information, Mechanism Design, Expectations, Speculations, Business Fluctuations, Cycles, Financial Markets and the Macroeconomy, Equities, Fixed Income Securities
Enable JavaScript for citation tools and additional paper interactions.