Research and Studies

Home > Research and Studies > Bank of Japan Working Paper Series, Review Series, and Research Laboratory Series > Bank of Japan Working Paper Series 2019 > (Research Paper) On Liquidity Shocks and Asset Prices

On Liquidity Shocks and Asset Prices

March 13, 2019
Pablo A. Guerron-Quintana*1
Ryo Jinnai*2

Abstract

In models of financial frictions, stock market booms tend to follow adverse liquidity shocks. This finding is clearly at odds with the data. We demonstrate that this counterfactual result is specific to real business cycle models with exogenous growth. Once we allow for both endogenous productivity and growth, this puzzling price dynamics easily disappear. Intuitively, the gloomy economic-growth outlook following the adverse liquidity shocks generates a predictable and negative long-run component in dividend growth, leading to the collapse of equity prices.

We thank Susanto Basu, Thorsten Drautzburg, Daniel Sanches, and seminar participants at the Bank of Japan for useful comments/discussions, and Yang Liu for research assistance. Ryo Jinnai gratefully acknowledges the financial support from the Ministry of Education, Culture, Sports, Science and Technology of the Japanese Government through JSPS KAKENHI Grants (24330094, 16K17080, 16H03626, and 17H00985) and the Hitotsubashi Institute for Advanced Study, as well as the hospitality of the Bank of Japan where a part of this research was conducted.

  1. *1Boston College and Espol
    E-mail : pguerron@gmail.com
  2. *2Hitotsubashi University
    E-mail : rjinnai@ier.hit-u.ac.jp

Notice

Papers in the Bank of Japan Working Paper Series are circulated in order to stimulate discussion and comments. Views expressed are those of authors and do not necessarily reflect those of the Bank.
If you have any comment or question on the working paper series, please contact each author. When making a copy or reproduction of the content for commercial purposes, please contact the Public Relations Department (post.prd8@boj.or.jp) at the Bank in advance to request permission. When making a copy or reproduction, the source, Bank of Japan Working Paper Series, should explicitly be credited.