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Liquidity and capital under uncertainty and changing market sentiment: A simple analysis

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  • Biagio Bossone

Abstract

This study introduces a general approach to investigate resource allocation and asset prices in an economy with uncertainty and shifts in market sentiment. The approach presents a number of key features: first, it proposes a choice‐theoretic model that determines the utility that the agents derive from holding assets with different liquidity. Second, it incorporates a variable (endogenously‐determined) cost structure of asset liquidation, which reflects the (in)efficiencies of the financial infrastructure and changes in market moods. Third, it also incorporates a model of expectations formation under uncertainty and changing market sentiment. While rich in structure, the approach offers a simple analytical framework to investigate resource allocation decision and asset price dynamics under various sources of uncertainty, and to explore the micro‐economics of speculative bubbles and boom–bust sequences. The use of a possible market‐specific prudential policy tool is discussed.

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  • Biagio Bossone, 2014. "Liquidity and capital under uncertainty and changing market sentiment: A simple analysis," Review of Financial Economics, John Wiley & Sons, vol. 23(2), pages 98-105, April.
    • Handle: RePEc:wly:revfec:v:23:y:2014:i:2:p:98-105
    DOI: 10.1016/j.rfe.2013.10.003
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    Cited by:

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