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Central bank haircut policy

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Author Info

  • James Chapman

    ()

  • Jonathan Chiu

    ()

  • Miguel Molico

    ()

Abstract

We present a model of central bank collateralized lending to study the optimal choice of the haircut policy. We show that a lending facility provides a bundle of two types of insurance: insurance against liquidity risk as well as insurance against downside risk of the collateral. Setting a haircut therefore involves balancing the trade-off between relaxing the liquidity constraints of agents on one hand, and increasing potential inflation risk and distorting the portfolio choices of agents on the other. We argue that the optimal haircut is higher when the central bank is unable to lend exclusively to agents who actually need liquidity. Finally, for an unexpected drop in the haircut, the central bank can be more aggressive than when setting a permanent level of the haircut.

(This abstract was borrowed from another version of this item.)

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File URL: http://hdl.handle.net/10.1007/s10436-010-0171-5
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Bibliographic Info

Article provided by Springer in its journal Annals of Finance.

Volume (Year): 7 (2011)
Issue (Month): 3 (August)
Pages: 319-348

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Handle: RePEc:kap:annfin:v:7:y:2011:i:3:p:319-348

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Web page: http://www.springerlink.com/link.asp?id=112370

Related research

Keywords: Collateral; Haircut; Liquidity; Central bank; Monetary policy; Search theory; E40; E42; E50;

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References

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  1. Martin, Antoine & Monnet, Cyril, 2011. "Monetary Policy Implementation Frameworks: A Comparative Analysis," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S1), pages 145-189, April.
  2. Bhattacharya, Joydeep & Haslag, Joseph H. & Martin, Antoine, 2009. "Why does overnight liquidity cost more than intraday liquidity?," Journal of Economic Dynamics and Control, Elsevier, vol. 33(6), pages 1236-1246, June.
  3. James T. E. Chapman & Antoine Martin, 2007. "Rediscounting Under Aggregate Risk with Moral Hazard," Working Papers 07-51, Bank of Canada.
  4. Aleksander Berentsen & Cyril Monnet, 2008. "Monetary policy in a channel system," Working Papers 08-7, Federal Reserve Bank of Philadelphia.
  5. Thorsten Koeppl & Cyril Monnet & Ted Temzelides, 2006. "A Dynamic Model of Settlement," Working Papers 1053, Queen's University, Department of Economics.
  6. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
  7. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  8. Antoine Martin & James McAndrews, 2008. "Should there be intraday money markets?," Staff Reports 337, Federal Reserve Bank of New York.
  9. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
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Cited by:
  1. Aleksander Berentsen & Alessandro Marchesiani & Christopher J. Waller, 2013. "Floor systems for implementing monetary policy: Some unpleasant fiscal arithmetic," ECON - Working Papers 121, Department of Economics - University of Zurich, revised Sep 2013.
  2. Sever, Can, 2014. "Systemic Liquidity Crisis with Dynamic Haircuts," MPRA Paper 55602, University Library of Munich, Germany.
  3. Bindseil, Ulrich & Jabłecki, Juliusz, 2013. "Central bank liquidity provision, risk-taking and economic efficiency," Working Paper Series 1542, European Central Bank.

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