Working Paper

The Collateral Premium and Levered Safe-Asset Production

Abstract: Banks are vital suppliers of money-like safe assets, which they produce by issuing short-term liabilities and pledging collateral. But their ability to create safe assets varies over time as leverage constraints fluctuate. I present a model to describe private safe-asset production when intermediaries face leverage constraints. I measure bank leverage constraints using bank-intermediated basis trades. The collateral premium — a strategy long Treasuries used more often as repo collateral and short Treasuries used less often — has a positive expected return of 22 basis points per year because the collateral premium compensates for bank leverage risk.

Keywords: Collateral; Bank leverage constraints; Repurchase agreement; Safe asset; Money;

JEL Classification: E40; E51; G12; G20;

https://doi.org/10.17016/FEDS.2022.046

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2022-07-12

Number: 2022-046