Money, Asset Prices and the Liquidity Premium

Seungduck Lee

MPRA Paper from University Library of Munich, Germany

Abstract: This paper examines the effect of monetary policy on the liquidity premium, i.e., the market value of the liquidity services that financial assets provide. To guide the empirical analysis, I set up a monetary search model in which bonds provide liquidity services in addition to money. The theory predicts that money supply and the nominal interest rate are positively correlated with the liquidity premium, but the latter is negatively correlated with the bond supply. The empirical analysis over the period from 1946 and 2008 confirms the theoretical findings. This indicates that liquid bonds are substantive substitutes for money and the opportunity cost of holding money plays a key role in asset price determination. The model can rationalize the existence of negative nominal yields, when the nominal interest rate is low and liquid bond supply decreases.

Keywords: asset price; money search model; liquidity; liquidity premium; money supply (search for similar items in EconPapers)
JEL-codes: E31 E41 E51 E52 G12 (search for similar items in EconPapers)
Date: 2016-08
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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https://mpra.ub.uni-muenchen.de/74615/6/MPRA_paper_74614.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/75077/10/MPRA_paper_75077.pdf revised version (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:74615

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