Frictional Markets, Asset Liquidity and Business Cycles
This thesis consists of three essays that use dynamic stochastic general equilibrium (DSGE) models to study the interactions between the goods sector and the financial sector of the economy in the presence of search frictions in the asset market. In Chapter 2, I construct a real business cycle model with search frictions in the asset market to endogenize asset liquidity. In the model, asset liquidity depends on the probability of matching a seller with an appropriate buyer. In this way, an exogenous shock in the real sector can cause asset liquidity to fluctuate by changing the tightness of the asset market. In this chapter, I demonstrate the existence of steady states, and examine the properties of the equilibria. In Chapter 3, I used the model discussed in Chapter 2, together with productivity and liquidity hocks estimated using a structural vector autoregression (SVAR) on U.S. data to investigate how asset liquidity and asset prices fluctuate in response to productivity and liquidity shocks, and how, in turn, these fluctuations magnify the impact of productivity shocks on economic activity. In addition, I compare the business cycle properties generated by the baseline model to models without search frictions in the asset market in order to assess the importance of search frictions. I find that productivity and liquidity shocks are equally important in explaining business cycles. The model also shows that productivity shocks generate pro-cyclical movements of hours worked and asset prices, which is not the case for liquidity shock. In Chapter 4, I compare two models with search frictions in the asset market that differ in terms of their assumptions regarding the supply and the demand sides of the market. Two factors discussed in the paper are adjustment costs and government bonds. After calibrating the models, I find that the model with both adjustment costs and government bonds generates pro cyclical movements in asset prices. In addition, the inclusions of adjustment costs significantly enlarge the volatility of asset prices because the adjustment costs prevent the asset price from immediately regressing to the steady state.
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