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Working Paper
International Reserves and Rollover Risk
We study the optimal accumulation of international reserves in a quantitative model of sovereign default with long-term debt and a risk-free asset. Keeping higher levels of reserves provides a hedge against rollover risk, but this is costly because using reserves to pay down debt allows the government to reduce sovereign spreads. Our model, parameterized to mimic salient features of a typical emerging economy, can account for a significant fraction of the holdings of international reserves, and the larger accumulation of both debt and reserves in periods of low spreads and high income. We ...
Discussion Paper
How Can Safe Asset Markets Be Fragile?
The market for U.S. Treasury securities experienced extreme stress in March 2020, when prices dropped precipitously (yields spiked) over a period of about two weeks. This was highly unusual, as Treasury prices typically increase during times of stress. Using a theoretical model, we show that markets for safe assets can be fragile due to strategic interactions among investors who hold Treasury securities for their liquidity characteristics. Worried about having to sell at potentially worse prices in the future, such investors may sell preemptively, leading to self-fulfilling “market runs” ...
Working Paper
The Effect of Safe Assets on Financial Fragility in a Bank-Run Model
Risk-averse investors induce competitive intermediaries to hold safe assets, thereby lowering the probability of a run and reducing financial fragility. We revisit Goldstein and Pauzner (2005), who obtain a unique equilibrium in the banking model of Diamond and Dybvig (1983) by introducing risky investment and noisy private signals. We show that, in the optimal demand-deposit contract subject to sequential service, banks hold safe assets to insure investors against investment risk. Consequently, fewer investors withdraw prematurely, which reduces the probability of a bank run. Safe asset ...
Working Paper
The Demand for Short-Term, Safe Assets and Financial Stability: Some Evidence and Implications for Central Bank Policies
A number of researchers have recently argued that the growth of the shadow banking system in the years preceding the recent U.S. financial crisis was driven by rising demand for "money-like" claims--short-term, safe instruments (STSI)--from institutional investors and nonfinancial firms. These instruments carry a money premium that lowers their yields. While government securities are an important part of the supply of STSI, financial intermediaries also take advantage of this money premium when they issue certain types of low-risk, short-term debt, such as asset-backed commercial paper or ...
Working Paper
U.S. Housing as a Global Safe Asset: Evidence from China Shocks
This paper demonstrates that the measured stock of China's holding of U.S. assets could be much higher than indicated by the U.S. net international investment position data due to unrecorded historical Chinese inflows into an increasingly popular global safe haven asset: U.S. residential real estate. We first use aggregate capital flows data to show that the increase in unrecorded capital inflows in the U.S. balance of payment accounts over the past decade is mainly linked to inflows from China into U.S. housing markets. Then, using a unique web traffic dataset that provides a direct measure ...
Working Paper
What Drives U.S. Treasury Re-use?
We study what drives the re-use of U.S. Treasury securities in the financial system. Using confidential supervisory data, we estimate the degree of collateral re-use at the dealer level through their collateral multiplier : the ratio between a dealer's total secured funding and their outright holdings financed through secured funding. We find that Treasury re-use increases as the supply of available securities decreases, especially when supply declines due to Federal Reserve asset purchases. We also find that non-U.S. dealers' re-use increases when profits from intermediating cash are high, ...
Working Paper
The Replacement of Safe Assets: Evidence from the U.S. Bond Portfolio
The expansion in financial sector "safe" assets, largely in the form of structured products from the U.S. and the Caribbean, in the lead-up to the global financial crisis has by now been fairly well documented. Using a unique dataset derived from security-level data on U.S. portfolio holdings of foreign securities, we show that since the crisis, it is mostly the foreign financial sector that appears to have met U.S. demand for safe and liquid investment assets by expanding its supply of debt securities. We also find a strong negative correlation between the foreign share of the U.S. ...
Working Paper
Investor Demands for Safety, Bank Capital, and Liquidity Measurement
We construct a model of a bank's optimal funding choice, where the bank negotiates with both safety-driven short-term bondholders and (mostly) risk-taking long-term bondholders. We establish that investor demands for safety create a negative relationship between the bank's capital choices and short-term funding, as well as negative relationships between capital and common measures of bank liquidity. Consistent with our model, our bank-level empirical analysis of these capital-liquidity tradeoffs show (1) that bank liquidity measures have a strong and negative relationship to its capital ratio ...
Working Paper
The Financial Origins of Non-Fundamental Risk
We formalize the idea that the financial sector can be a source of non-fundamental risk. Households' desire to hedge against price volatility can generate price volatility in equilibrium, even absent fundamental risk. Fearing that asset prices may fall, risk-averse households demand safe assets from leveraged intermediaries, whose issuance of safe assets exposes the economy to self-fulfilling fire sales. Policy can eliminate nonfundamental risk by (i) increasing the supply of publicly backed safe assets, through issuing government debt or bailing out intermediaries, or (ii) reducing the ...
Working Paper
A Theory of Safe Asset Creation, Systemic Risk, and Aggregate Demand
This paper presents a theory of safe asset creation and the interactions between systemic risk and aggregate demand. The creation of private safe assets by financial intermediaries requires them to take leverage, which generates a risk of future crisis (systemic risk) in which intermediaries liquidate assets to service their debt. In contrast, the creation of public safe assets by the government does not generate systemic risk as the government's power to tax allows it to better absorb losses. The level of systemic risk determines the neutral rate of interest through households' precautionary ...