Information and Liquidity

We study how recognizability affects assets’ acceptability, or liquidity. Some assets, like US currency, are readily accepted because sellers can easily recognize their value, unlike stock certificates, bonds or foreign currency, say. This idea is common in monetary economics, but previous models deliver equilibria where less-recognizable assets are always accepted with positive probability, never probability 0. This is inconvenient when prices are determined through bargaining, which is difficult with private information. We construct models where agents reject outright assets that they cannot recognize, at least for some parameters. Thus, information frictions generate liquidity differences without overly complicating the analysis. ∗We would like to thank Guillaume Rocheteau for an excellent discussion of this paper, as well as many seminar and conference participants for their input. Postlewaite and Wright acknowledge support from the National Science Foundation, and Lester acknowledges support from the Academic Development Fund at the University of Western Ontario. The usual disclaimer applies.