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Covered bonds, core markets, and financial stability

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  • Kartik Anand
  • James Chapman
  • Prasanna Gai

Abstract

We examine the financial stability implications of covered bonds. Banks issue covered bonds by encumbering assets on their balance sheet and placing them within a dynamic ring fence. As more assets are encumbered, jittery unsecured creditors may run, leading to a banking crisis. We provide conditions for such a crisis to occur. We examine how different over-the-counter market network structures influence the liquidity of secured funding markets and crisis dynamics. We draw on the framework to consider several policy measures aimed at mitigating systemic risk, including caps on asset encumbrance, global legal entity identifiers, and swaps of good for bad collateral by central banks.

Suggested Citation

  • Kartik Anand & James Chapman & Prasanna Gai, 2012. "Covered bonds, core markets, and financial stability," SFB 649 Discussion Papers SFB649DP2012-065, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  • Handle: RePEc:hum:wpaper:sfb649dp2012-065
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    File URL: http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2012-065.pdf
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    References listed on IDEAS

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    1. Kartik Anand & Alan Kirman & Matteo Marsili, 2013. "Epidemics of rules, rational negligence and market crashes," The European Journal of Finance, Taylor & Francis Journals, vol. 19(5), pages 438-447, May.
    2. Jean-Charles Rochet & Xavier Vives, 2004. "Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?," Journal of the European Economic Association, MIT Press, vol. 2(6), pages 1116-1147, December.
    3. Darrell Duffie & Nicolae Gârleanu & Lasse Heje Pedersen, 2007. "Valuation in Over-the-Counter Markets," Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 1865-1900, November.
    4. Holmström, Bengt, 2013. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262518536.
    5. William A. Brock & Steven N. Durlauf, 2001. "Discrete Choice with Social Interactions," Review of Economic Studies, Oxford University Press, vol. 68(2), pages 235-260.
    6. Blume Lawrence E., 1993. "The Statistical Mechanics of Strategic Interaction," Games and Economic Behavior, Elsevier, vol. 5(3), pages 387-424, July.
    7. Gai, Prasanna & Shin, Hyun Song, 2004. "Debt maturity structure with pre-emptive creditors," Economics Letters, Elsevier, pages 195-200.
    8. Lagos, Ricardo & Rocheteau, Guillaume & Weill, Pierre-Olivier, 2011. "Crises and liquidity in over-the-counter markets," Journal of Economic Theory, Elsevier, vol. 146(6), pages 2169-2205.
    9. Manmohan Singh, 2011. "Velocity of Pledged Collateral; Analysis and Implications," IMF Working Papers 11/256, International Monetary Fund.
    10. Manmohan Singh & Peter Stella, 2012. "Money and Collateral," IMF Working Papers 12/95, International Monetary Fund.
    11. Vincent Glode & Richard C. Green & Richard Lowery, 2012. "Financial Expertise as an Arms Race," Journal of Finance, American Finance Association, vol. 67(5), pages 1723-1759, October.
    12. Beirne, John & Dalitz, Lars & Ejsing, Jacob & Grothe, Magdalena & Manganelli, Simone & Monar, Fernando & Sahel, Benjamin & Sušec, Matjaž & Tapking, Jens & Vong, Tana, 2011. "The impact of the Eurosystem's covered bond purchase programme on the primary and secondary markets," Occasional Paper Series 122, European Central Bank.
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    Citations

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    Cited by:

    1. Prasanna Gai & Andrew G Haldane & Sujit Kapadia & Benjamin Nelson, 2013. "Bank Funding and Financial Stability," RBA Annual Conference Volume,in: Alexandra Heath & Matthew Lilley & Mark Manning (ed.), Liquidity and Funding Markets Reserve Bank of Australia.
    2. repec:eee:quaeco:v:66:y:2017:i:c:p:314-327 is not listed on IDEAS
    3. Alexandra Heath & Gerard Kelly & Mark Manning, 2013. "OTC Derivatives Reform: Netting and Networks," RBA Annual Conference Volume,in: Alexandra Heath & Matthew Lilley & Mark Manning (ed.), Liquidity and Funding Markets Reserve Bank of Australia.

    More about this item

    Keywords

    covered bonds; over-the-counter markets; systemic risk; asset encumbrance; legal entity identifiers; velocity of collateral;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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