The (Unintended?) Consequences of the Largest Liquidity Injection Ever
Abstract: 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.
File(s): File format is application/pdf https://www.federalreserve.gov/econresdata/feds/2017/files/2017011pap.pdf
Part of Series: Finance and Economics Discussion Series
Publication Date: 2017-01
Pages: 57 pages