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Toxic Assets and Market Freezes

Author

Listed:
  • Chao Gu

    (University of Missouri)

  • Guido Menzio

    (New York University and NBER)

  • Randall Wright

    (Zhejiang University, University of Wisconsin and Dale Mortensen Center at Aarhus)

  • Yu Zhu

    (Bank of Canada)

Abstract

We study economies where some assets are toxic –i.e., they have negative returns –but still have positive prices because they provide liquidity as payment instruments or as collateral. Even without changes in fundamentals markets can, as a self-fulfi…lling prophecy, freeze and thaw recurrently: toxic assets stop trading for a spell, then restart. We show markets without toxic assets might have hot and cold spells, where prices and quantities ‡fluctuate, but cannot freeze and thaw (at least without nonconvexities). Freezes can occur when there are toxic assets plus fi…at currency, and whether these assets trade for goods or trade for money.

Suggested Citation

  • Chao Gu & Guido Menzio & Randall Wright & Yu Zhu, 2020. "Toxic Assets and Market Freezes," Working Papers 2001, Department of Economics, University of Missouri.
    • Handle: RePEc:umc:wpaper:2001
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    toxic assets; market freezes; negative returns; liquidity;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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