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Safe-Asset Shortages: Evidence from the European Government Bond Lending Market

Published online by Cambridge University Press:  20 October 2020

Reena Aggarwal ,
Jennie Bai  and
Luc Laeven
Reena Aggarwal*
Affiliation:
Georgetown University McDonough School of Business and European Corporate Governance Institute
Jennie Bai
Affiliation:
Georgetown University McDonough School of Business and National Bureau of Economic Researchjennie.bai@georgetown.edu
Luc Laeven
Affiliation:
European Central Bank and Center for Economic and Policy Researchluc.laeven@ecb.europa.eu
*
aggarwal@georgetown.edu (corresponding author)
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Abstract

We identify the unique role of the government bond lending market in collateral transformation during periods of market stress. Using a novel database, we provide evidence that safe assets in the lending market have higher demand, higher borrowing cost, and higher usage of noncash collateral relative to nonsafe assets during stressed market conditions. Moreover, we find that market participants are able to obtain safe assets using relatively low-quality noncash collateral, allowing for collateral transformation. We show that policy interventions by central banks can help reduce safe-asset shortages by returning sought-after safe assets to the market.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 56 , Issue 8 , December 2021 , pp. 2689 - 2719
Copyright
© The Author(s), 2020. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

We thank Tobias Adrian, Markus Brunnermeier, Hui Chen, Paolo Colla, Stefano Corradin, Darrell Duffie, Gary Gorton, Jarrad Harford (the editor), Andrew Karolyi, Arvind Krishnamurthy, Stefan Lewellen (the referee), Emanuel Moench, Stefan Nagel, Maureen O’Hara, Pedro Saffi, Hyun Shin, Manmohan Singh, Jeremy Stein, Jason Sturgess, and seminar participants at the 2016 NBER Summer Institute Macro, Money, and Financial Frictions workshop, ECB 2015 Workshop on Money Markets and Central Bank Balance Sheets, Yale SOM 2016 workshop on Financial Stability, 2016 China International Conference in Finance, 2019 Consob-Bocconi Baffi-Carefin conference, 2017 FRIC Conference on Financial Frictions, the 2016 European Banking Center network conference, 2016 Financial Stability Conference by OFR and Federal Reserve Bank of Cleveland, the 2017 Public Investors Conference by BIS / World Bank / Bank of Canada, 2017 Federal Reserve Bank of Boston, BIS, IMF, FMA Asia Pacific Conference, 2017 FMA Europe Conference, Cornell University, Georgetown University, University of North Carolina Chapel Hill, and the University of Zurich for helpful comments. We also benefitted from conversations with several industry participants, particularly Glenn Horner from State Street and Shirley McCoy and Robert Taub from J.P. Morgan. Aggarwal acknowledges support from the Robert E. McDonough endowment at Georgetown University’s McDonough School of Business. The views expressed here are those of the authors and not those of the ECB or Eurosystem.

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