Cash-in-the-Market Pricing in a Model with Money and Over-the-Counter Financial Markets

Entrepreneurs need cash to \u85nance their investments. Since cash is costly to hold, entrepreneurs underinvest. If entrepreneurs are able to access secondary \u85nancial mar-kets, then they can sell some of their less liquid assets for cash and invest at a higher level. When the secondary \u85nancial markets are over-the-counter (OTC), the amount of liquidity (cash) that is in the market a¤ects asset prices. In particular, higher levels of liquidity lead to higher asset prices. Since the amount of cash in the market a¤ects assets prices, asset prices can uctuate over time even though asset fundamentals are unchanged. Bid and ask prices naturally arise in an OTC market. We \u85nd that the bid-ask spread is negatively correlated with asset returns which is well documented in the literature and positively correlated with ination. Importantly, we also \u85nd that an increase in ination increases returns and, hence, decreases asset prices