ASSET PRICING MODEL: Coordination failures 2


This (inefficient) equilibrium exhibits a coordination failure. It illustrates in a stark manner that the liquidity available to the corporate sector depends on the liability side as well as the asset side. In this respect, it is interesting to note that a recent speech by the French finance minister called for “well-oriented savings,” meaning a switch by households from short-term market investments towards long-term, equity investments that will benefit the productive sector.

A couple of additional remarks can be made. First, the government can create aggregate liquidity by offering unemployment insurance. Unemployment insurance (above Ci) here eliminates the consumers’ demand for liquidity and restores the efficient equilibrium. Second, the multiplicity of equilibria could not arise in an Arrow-Debreu economy, because in a perfect capital market, firms would be able to pledge their entire date-2 income which would be enough to pay workers at date 1 in both states.

Liquidity creation through price support policies: the example of commercial real estate.

In many countries the recessions of the late 80s and early 90s have left the financial institutions burdened with depreciated commercial real estate. While banks, badly in need of liquidity, would have liked to divest their real estate holdings, they realized collectively that dumping real estate assets on the market simultaneously would have a disastrous impact on prices in a state of low demand for commercial real estate. In some countries (e.g., in Prance), cartel-like restraints on the disposition of real estate prevented prices from falling further.28 To an industrial organization observer, this behavior has all the attributes of a price-fixing case. This section argues that there is more to it than just collusion and that price stabilization may actually have helped to improve economic efficiency.

To illustrate the point, suppose that, as in section 6.1, continuation at date 1 requires paying for an input, but this time, let the input be commercial real estate rather than labor. In case of continuation, one unit of commercial real estate is needed. The date-0 investment yields date-1 income xl = 0 with probability Д and хн > 0 with probability /я = 1 — /t- As in section 2, reinvestment yields a private benefit В at date 2, but no pledgeable income (X = 0 in the notation of section 6.1).

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