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Central bank haircut policy

  • James Chapman

    ()

  • Jonathan Chiu

    ()

  • Miguel Molico

    ()

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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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
Contact details of provider: Web page: http://www.springerlink.com/link.asp?id=112370

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  1. Jeffrey Lacker, 2001. "Collateralized Debt as the Optimal Contract," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 842-859, October.
  2. Joydeep Bhattacharya & Joseph H. Haslag & Antoine Martin, 2007. "Why does overnight liquidity cost more than intraday liquidity?," Staff Reports 281, Federal Reserve Bank of New York.
  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, 2007. "Monetary Policy in a Channel System," CESifo Working Paper Series 1929, CESifo Group Munich.
  5. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  6. ANTOINE MARTIN & JAMES McANDREWS, 2010. "Should There Be Intraday Money Markets?," Contemporary Economic Policy, Western Economic Association International, vol. 28(1), pages 110-122, 01.
  7. Koeppl, Thorsten Volker & Monnet, Cyril & Temzelides, Ted, 2006. "A dynamic model of settlement," Working Paper Series 0604, European Central Bank.
  8. Martin, Antoine & Monnet, Cyril, 2011. "Monetary Policy Implementation Frameworks: A Comparative Analysis," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S1), pages 145-189, April.
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