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Uncertainty and Liquidity

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  • Alberto Giovannini

Abstract

This paper studies a model where money is valued for the liquidity services it provides in the future. These liquidity services cannot be provided by any other asset. Changes in expectations of the value of future liquidity services affect the desired proportions of money and other assets in agents' portfolios, and, as a result, they change nominal interest rates and real stock prices. The paper concentrates on the effects of stochastic fluctuations in the distribution of exogenous shocks. I find that changes in dividend risk have effects opposite to those in standard dynamic portfolio models without money. Furthermore, shifts between money and other assets that are driven by precautionary liquidity demand make nominal interest rates capture information about the uncertainty in the economy more accurately than any other prices in the asset markets.

Suggested Citation

  • Alberto Giovannini, 1987. "Uncertainty and Liquidity," NBER Working Papers 2296, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:2296
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    Cited by:

    1. Rankin, Neil, 1998. "Nominal rigidity and monetary uncertainty in a small open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 22(5), pages 679-702, May.
    2. Bossone, Biagio, 1999. "The role of trust in financial sector development," Policy Research Working Paper Series 2200, The World Bank.
    3. Jamsheed Shorish & Stephen E. Spear, 2005. "Shaking the tree: an agency-theoretic model of asset pricing," Annals of Finance, Springer, vol. 1(1), pages 51-72, January.
    4. Rankin, Neil, 1998. "Nominal rigidity and monetary uncertainty," European Economic Review, Elsevier, vol. 42(1), pages 185-199, January.
    5. Hodrick, Robert J & Kocherlakota, Narayana R & Lucas, Deborah, 1991. "The Variability of Velocity in Cash-in-Advance Models," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 358-384, April.
    6. Hodrick, Robert J., 1989. "Risk, uncertainty, and exchange rates," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 433-459, May.
    7. Alberto Giovannini & Philippe Jorion, 1988. "The Time-Variation of Risk and Return in the Foreign Exchange and Stock Markets," NBER Working Papers 2573, National Bureau of Economic Research, Inc.
    8. Bossone, Biagio, 2014. "Liquidity and capital under uncertainty and changing market sentiment: A simple analysis," Review of Financial Economics, Elsevier, vol. 23(2), pages 98-105.

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