Abstract
Is asset liquidity a source of price volatility? We answer this question within a continuous-time, New Monetarist economy under extrinsic uncertainty where the role of an asset to finance expenditure shocks depends on its pledgeability. If assets are intrinsically valuable and pledgeability is exogenous, then their prices are invariant to extrinsic uncertainty – unlike environments with discrete-time pricing that can feature sunspot equilibria. We derive conditions under which extrinsic uncertainty matters when pledgeability is endogenous and varies with the asset price or its rate of return. In the latter case, we link sunspot equilibria to deterministic cycles.
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