| Abstract: |
During the financial crisis apparently centralized markets continued to
function while trade in OTC markets froze. We use search-and-bargaining theory
to ascertain conditions that allow trade to temporarily freeze in
decentralized markets, focusing on the roles of liquidity and self-fulfilling
prophecies. We show standard models can have recurrent, belief-driven hot and
cold spells, but not freezes and thaws. A simple specification that has
freezes assumes negative returns. A more realistic one incorporates
information frictions (costly asset-quality verification). Another uses
different frictions to get credit freezes. We also discuss policy
implications, and go into detail on the nature of OTC markets. |