UC Davis

Financial market has been essential to macroeconomy and is crucial in understanding the policy transmission. Frictions in the financial market can shape agents’ preference towards various financial instruments, and give extra incentives for investors to hold assets with better liquidity property. The price premium derived from such liquidity concern can further aect firms’ financial decision, i.e., dividend policy. Furthermore, since real money balance, joint with dividend payment, aect agents’ liquidity position and hence demand for the dividend assets, monetary policy can have important impact on firms’ dividend decision and investment plan. Also, as the secondary asset market and credit become more widely available, antoher question to be asked is whether such change always improves the welfare. This dissertation focuses on the role of market friction and liquidity in understanding these issues.

In Chapter One, I provide a new theoretical resolution to the long-standing dividend puzzle. And I answer the question that why do agents have preference towards dividend assets over non-dividend assets, despite the fact that the tax legislation is unfavorable towards dividend payment when comparing to the same amount of capital gain. To answer this question, I build a partial equilibrium search-theoretic model taking asset supplies as given. In this model, dividend assets are not just a store of value but also provide direct liquidity when agents have urgent consumption need. The model delivers several testable implications. First of all, in an economy where some transactions require a proper means of payment, dividend assets serve as a better liquidity instrument when comparing to non-dividend assets, and hence carry a price premium. Second, the turnover ratio of non-dividend assets is higher than the turnover ratio of dividend asset. Lastly, the price premium from dividend payment increases as the market becomes less liquid. I then provide empirical evidence to support all three propositions.

In Chapter Two, I study firms’ optimal dividend decision. More specifically, I ask the question that, if paying dividend is always a better policy than not paying dividend or vice versa, then why not all firms have the same dividend policy. To answer this question, I endogenize the asset supplies which are taken as given in Chapter One. I argue that firms are facing a trade-o between having higher price, if they decided to pay dividend, versus a higher TFP, if they decided to not pay dividend but use the resource in a more productive way, i.e., R&D activities. With such trade-o, in equilibrium firms will be indierent between paying dividend versus not paying dividend, hence have dierent dividend policy. For monetary policy implication, the model predicts that a contractionary monetary policy can hurt the economy not only through the traditional channel of depressing real money balance, but also through a less-explored channel of discouraging aggregate R&D activities.

In Chapter Three, a joint work with Athanasios Geromichalos, we study whether the introduction of alternative (to money) payment instruments is always welfare improving. The common belief is that the introduction of credit reduces market friction and hence should improve agents’ welfare. However, we show that this is not always true. More specifically, more credit ex post means that transactions will not be hindered by lack of liquidity, however ex ante, easier access to credit means agents have less incentive to hold money, which will hurt transactions in bilateral meetings where credit is not accepted. Our model also offers a theoretical explanation to the growing empirical literature suggesting that increased access to credit is often followed recession and economic hardships.