Template-Type: ReDIF-Paper 1.0
Author-Name: Athanasios Geromichalos
Author-Name-First: Athanasios
Author-Name-Last: Geromichalos
Author-Name: Lucas Herrenbrueck
Author-Name-First: Lucas
Author-Name-Last: Herrenbrueck
Author-Name: Sukjoon Lee
Author-Name-First: Sukjoon
Author-Name-Last: Lee
Author-Workplace-Name: Department of Economics, University of California Davis
Title: Asset Safety versus Asset Liquidity
Abstract: Recently, a lot of attention has been paid to the role “safe and liquid assets” play in the
 macroeconomy. Many economists take as given that safer assets will also be more liquid,
 and some go a step further by practically using the two terms as synonyms. However,
 they are not synonyms: safety refers to the probability that the (issuer of the) asset will
 pay the promised cash flow, and liquidity refers to the ease with which an asset can be
 sold if needed. Mixing up these terms can lead to confusion and wrong policy recommendations.
 In this paper, we build a multi-asset model in which an asset’s safety and
 liquidity are well-defined and distinct from one another. Treating safety as a primitive,
 we examine the relationship between an asset’s safety and liquidity in general equilibrium.
 We show that the commonly held belief that “safety implies liquidity” is generally
 justified, but there may be exceptions. We then describe the conditions under which a
 relatively riskier asset can be more liquid than its safe(r) counterparts. Finally, we use our
 model to rationalize the puzzling observation that AAA corporate bonds are considered
 less liquid than (the riskier) AA corporate bonds.
Length: 42
File-URL: https://repec.dss.ucdavis.edu/files/EZ2zr1FRsCKbHsSrR9JC1M5t/safetyvsliquidity-v1.0.pdf
File-Format: application/pdf
Number: 326
Classification-JEL: E31, E43, E52, G12
KeyWords: asset safety, asset liquidity, over-the-counter markets, liquidity premium
Creation-Date: 20181119
Handle: RePEc:cda:wpaper:326