Money, Asset Prices and the Liquidity Premium

Lee, Seungduck (2016): Money, Asset Prices and the Liquidity Premium.

Abstract

This paper examines the effect of monetary policy on the liquidity premium, i.e., the market value of the liquidity services that financial assets provide. To guide the empirical analysis, I set up a monetary search model in which bonds provide liquidity services in addition to money. The theory predicts that money supply and the nominal interest rate are positively correlated with the liquidity premium, but the latter is negatively correlated with the bond supply. The empirical analysis over the period from 1946 and 2008 confirms the theoretical findings. This indicates that liquid bonds are substantive substitutes for money and the opportunity cost of holding money plays a key role in asset price determination. The model can rationalize the existence of negative nominal yields, when the nominal interest rate is low and liquid bond supply decreases.

• Item Type: MPRA Paper
• Language: English
• Keywords: asset price, money search model, liquidity, liquidity premium, money supply
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E51 - Money Supply ; Credit ; Money Multipliers; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates

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