Liquidity and Asset Prices: How Strong are the Linkages

19 Pages Posted: 7 Jul 2009

See all articles by Christian Dreger

Christian Dreger

European University Viadrina Frankfurt (Oder); IZA Institute of Labor Economics; Chinese Academy of Social Sciences (CASS)

Jürgen Wolters

Free University of Berlin (FUB)

Date Written: February 1, 2009

Abstract

The appropriate design of monetary policy in integrated financial markets is one of the most challenging areas for central banks. One hot topic is whether the rise in liquidity in recent years has contributed to the formation of price bubbles in asset markets. If strong linkages exist, the inclusion of asset prices in the monetary policy rule can eventually limit speculative runs and negative effects on the real economy in the future. We explore the impacts of liquidity shocks on real share and house prices and the influence of wealth prices on liquidity. VAR models are specified for the US and the euro area. To control for international spillovers, global VARs are also considered. Differences in the results can provide a measure on the impact of financial market integration. The specifications point to some impact of liquidity shocks on house prices, while asset prices are not affected.

Keywords: Liquidity shocks, asset prices, GVAR analysis, monetary policy

JEL Classification: E44, G10, C32, C52

Suggested Citation

Dreger, Christian and Wolters, Jürgen, Liquidity and Asset Prices: How Strong are the Linkages (February 1, 2009). DIW Berlin Discussion Paper No. 860, Available at SSRN: https://ssrn.com/abstract=1430982 or http://dx.doi.org/10.2139/ssrn.1430982

Christian Dreger (Contact Author)

European University Viadrina Frankfurt (Oder) ( email )

Frankfurt (Oder)
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Chinese Academy of Social Sciences (CASS) ( email )

Beijing, 100732
China

Jürgen Wolters

Free University of Berlin (FUB) ( email )

Van't-Hoff-Str. 8
D-10785 Berlin, Berlin 14195
Germany
+49-30-838-2014 (Phone)
+49-30-838-4142 (Fax)

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