Abstract
This paper analyzes the role of money in asset markets characterized by search
frictions. We develop a dynamic framework that brings together a model for illiquid
financial assets `a la Duffie, G arleanu, and Pedersen, and a search-theoretic
model of monetary exchange `a la Lagos and Wright. The presence of decentralized
financial markets generates an essential role for money, which helps investors
re-balance their portfolios. We provide conditions that guarantee the existence
of a monetary equilibrium. In this case, asset prices are always above their fundamental
value, and this differential represents a liquidity premium. We are able
to derive an asset pricing theory that delivers an explicit connection between
monetary policy, asset prices, and welfare. We obtain a negative relationship
between inflation and equilibrium asset prices. This key result stems from the
complementarity between money and assets in our framework