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Dimensions of Economic Theory and PolicyEssays for Anjan Mukherji$
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Krishnendu Ghosh Dastidar, Hiranya Mukhopadhyay, and Uday Bhanu Sinha

Print publication date: 2011

Print ISBN-13: 9780198073970

Published to Oxford Scholarship Online: September 2012

DOI: 10.1093/acprof:oso/9780198073970.001.0001

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Liquidity Preference and Information

Liquidity Preference and Information

(p.191) 12 Liquidity Preference and Information
Dimensions of Economic Theory and Policy

Sandeep Kapur

Oxford University Press

Due to the recent financial crisis, the issue of liquidity has emerged. Illiquidity reflects frictions in markets, and in asset markets can arise for various reasons. This chapter analyses how the preference for liquidity is affected by the precision of anticipated information. Given a subjective ordering of investment portfolios by their liquidity, it identifies a sufficient condition under which the prospect of finer resolution of uncertainty results in a preference for more liquid positions. It then demonstrates how this condition might emerge naturally in some standard classes of sequential decision problems. The chapter considers the simplest setting whereby an agent must make choices in two periods, with the initial choice affecting the set of subsequent choices. When one has to choose between a discrete set of irreversible investments and liquid cash, greater informativeness is expected to increase the reward, other things equal, to holding liquid cash.

Keywords:   liquidity, information, investment portfolios, uncertainty, sequential decision problems, choices, liquid cash, irreversible investments

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