The Korean Economic Review
Recognizability and Liquidity of Assets
Young Sik Kim (Seoul National University), Manjong Lee (Korea University)Year 2012Vol. 28No. 2
The recognizability of assets is embedded into a standard search model to determineliquidity returns. Assuming that money is universally recognizable but bond is not, two typesof trades arise–one where both money and bond are accepted and the other where onlymoney is accepted as a medium of exchange–depending on a seller’s strategy of accepting orrejecting the bond of unrecognized quality and a buyer’s strategy of carrying the counterfeitbond. Equilibrium restrictions imply that the liquidity differentials between money andbond tend to increase with the recognizability problem. Money commands higher liquiditythan bond by providing additional liquidity service when sellers reject the bond ofunrecognized quality as well as when they recognize counterfeit bond. The coexistence ofmoney and bond requires a higher full (liquidity augmented) return for bond than money,implying a positive liquidity premium.