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Central Bank Haircut Policy

  • James Chapman, Jonathan Chiu, and 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.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/10/wp10-23.pdf
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Paper provided by Bank of Canada in its series Working Papers with number 10-23.

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Length: 44 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:bca:bocawp:10-23
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Web page: http://www.bank-banque-canada.ca/

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  1. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
  2. Berentsen, Aleksander & Monnet, Cyril, 2008. "Monetary policy in a channel system," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1067-1080, September.
  3. Koeppl, Thorsten Volker & Monnet, Cyril & Temzelides, Ted, 2006. "A dynamic model of settlement," Working Paper Series 0604, European Central Bank.
  4. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  5. James T.E. Chapman & Antoine Martin, 2013. "Rediscounting under Aggregate Risk with Moral Hazard," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(4), pages 651-674, 06.
  6. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
  7. Bhattacharya, Joydeep & Haslag, Joseph & Martin, Antoine, 2007. "Why Does Overnight Liquidity Cost More Than Intraday Liquidity?," Staff General Research Papers 13096, Iowa State University, Department of Economics.
  8. Antoine Martin & James McAndrews, 2008. "Should there be intraday money markets?," Staff Reports 337, Federal Reserve Bank of New York.
  9. Antoine Martin & Cyril Monnet, 2009. "Monetary policy implementation frameworks: a comparative analysis," Working Papers 09-27, Federal Reserve Bank of Philadelphia.
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