"Endogenous Liquidity and the Business Cycle"
Publication type: Working paper
I present a model in which asymmetric information in capital quality endogenously determines the amount liquidity in an economy. Liquid funds are key to relax financial constraints that affect investment and employment decisions. These funds are obtained by selling capital or using capital as collateral. Liquidity is determined by balancing the costs of obtaining funding under asymmetric information and the benefits of relaxing financial constraints. Aggregate fluctuations can be attributed to increases in the dispersion of capital quality which increment the cost of obtaining liquidity. The model can generate patterns for quantities and credit conditions similar to the Great Recession.
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