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The (unintended?) consequences of the largest liquidity injection ever

Listed author(s):
  • Matteo Crosignani
  • Miguel Faria-e-Castro
  • Luís Fonseca

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 incentivized 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 8.4% of amount outstanding. The resumption of public debt issuance is consistent with a strategic reaction of the debt agency to the observed yield curve steepening. JEL Classification: E58, G21, G28, H63

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Paper provided by European Systemic Risk Board in its series ESRB Working Paper Series with number 31.

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Date of creation: Dec 2016
Handle: RePEc:srk:srkwps:201631
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