Liquidity Provision with OTC market

Lun, 22/11/2021 - 13:00 / 14:00

405, Viale Romania

Speaker: Ugo Zannini , Luiss

Co-author: Vittorio Larocca

Abstract

We investigate if over-the-counter trades provide insurance to liquidity risk in an economy à la Diamond and Dybvig (1983). To this end, after the liquidity shock takes place agents can trade among themselves in an OTC market with bilateral meetings and bargaining.
Under Nash's (1950) solution, we derive the necessary and sufficient conditions for the existence of a symmetric risk-sharing equilibrium. First, the matching probability of the patient type must be sufficiently high. Second, the impatient type's bargaining power must belong to a specific subset, which extremes increase with the patient type's matching probability. Third, investing all the endowment in the long-term asset must not be a profitable deviation. As closed-form solutions are unavailable, we show by way of numerical example for the class of CRRA utility functions that the OTC market provides liquidity insurance.
Under Kalai's (1977) proportional solution, a risk-sharing equilibrium does never exist.