Working Paper: NBER ID: w29210
Authors: Chao Gu; Guido Menzio; Randall Wright; Yu Zhu
Abstract: During the financial crisis apparently centralized markets continued to function while trade in OTC markets froze. We use search-and-bargaining theory to ascertain conditions that allow trade to temporarily freeze in decentralized markets, focusing on the roles of liquidity and self-fulfilling prophecies. We show standard models can have recurrent, belief-driven hot and cold spells, but not freezes and thaws. A simple specification that has freezes assumes negative returns. A more realistic one incorporates information frictions (costly asset-quality verification). Another uses different frictions to get credit freezes. We also discuss policy implications, and go into detail on the nature of OTC markets.
Keywords: No keywords provided
JEL Codes: D53; D83; E30; E44; E52; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| negative returns (G12) | market freezes (D49) |
| information frictions (D89) | market freezes (D49) |
| self-referential liquidity (E41) | market activity (G10) |
| agents' beliefs about others' actions (D83) | self-referential liquidity (E41) |
| low inflation (E31) | likelihood of market freezes (E44) |