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Report

Fragility of Safe Asset Markets


Abstract: We model a safe asset market with investors valuing safety, investors valuing liquidity, and constrained dealers. While safety investors and liquidity investors can interact symbiotically with offsetting trades in times of stress, we show that liquidity investors’ strategic interaction harbors the potential for self-fulfilling fragility. Surprisingly, standard flight to safety in times of stress can have a destabilizing effect and trigger a dash for cash by liquidity investors. This explains how safe asset markets can experience price crashes, as in March 2020. The announcement and execution of policy interventions play important roles for the functioning of safe asset markets.

Keywords: safe assets; liquidity shocks; global games; Treasury securities; COVID-19;

JEL Classification: C7; G01; G1; E4; E5;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2022-07-01

Number: 1026