Score contribution per author:
α: calibrated so average coauthorship-adjusted count equals average raw count
We study government policies designed to increase liquidity by extending government guarantees to fundamentally illiquid assets. We characterize the effects of such policies on equilibrium price dynamics, trading strategies, and welfare. We build on the strategic trading framework of Brunnermeier and Pedersen (2005) and Carlin, Lobo, and Viswanathan (2007) by adding multiple assets and by modeling all agents utility functions. The assets in our model differ in their fundamental liquidity, i.e., the price reaction of the nonstrategic (or retail) traders to amounts sold by the strategic traders. Nonstrategic traders are willing to accept greater amounts of the more liquid asset with less short-term price reaction. These additions allow us to consider the welfare implications of, for example, shifting some assets from the illiquid category to the liquid category, a proxy for government guarantees on a risky asset. As in other models of this type, the strategic players predate on each other when one becomes distressed and is forced to liquidate its holdings. As others have shown, the more liquid