State Prices, Liquidity, and Default

Espinoza, Raphaël, Goodhart, Charles and Tsomocos, Dimitrios (2009) State Prices, Liquidity, and Default. Economic Theory, 39 (2). pp. 177-194.

Abstract

We show, in a monetary exchange economy, that asset prices in a complete markets general equilibrium are a function of the supply of liquidity by the Central Bank, through its effect on default and interest rates. Two agents trade goods and nominal assets to smooth consumption across periods and future states, in the presence of cash-in-advance financing costs that have effects on real allocations. We show that higher spot interest rates reduce trade and as a result increase state prices. Hence, states of nature with higher interest rates are also states of nature with higher risk-neutral

Item Type: Article
Keywords: Cash-in-advance constraints; Default; Asset prices; Risk-neutral probabilities; finance
Subject(s): Finance
Date Deposited: 11 Feb 2012 17:54
Last Modified: 24 Feb 2017 15:26
Funders: N/A
URI: http://eureka.sbs.ox.ac.uk/id/eprint/1853

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