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The (Unintended?) Consequences of the Largest Liquidity Injection Ever

Listed author(s):
  • Crosignani, Matteo

    (Federal Reserve Board)

  • Faria-e-Castro, Miguel

    ()

    (Federal Reserve Bank of St. Louis)

  • Fonseca, Luis

    (London Business School)

We study the design of lender of last resort interventions and show that the provision of long-term liquidity incentivizes purchases of high-yield short-term securities by banks. Using a unique security-level data set, we find that the European Central Bank's three-year Long-Term Refinancing Operation caused Portuguese banks to purchase short-term domestic government bonds that could be pledged to obtain central bank liquidity. This "collateral trade" effect is large, as banks purchased short-term bonds equivalent to 10.6% of amounts outstanding. The steepening of peripheral sovereign yield curves after the policy announcement is consistent with the equilibrium effects of the collateral trade.

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File URL: https://doi.org/10.20955/wp.2017.039
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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2017-39.

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Length: 46 pages
Date of creation: 01 Nov 2017
Handle: RePEc:fip:fedlwp:2017-039
DOI: 10.20955/wp.2017.039
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