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Collateral and Short Squeezing of Liquidity in Fixed Rate Tenders

London Business School Working Paper No. IFA 329

23 Pages Posted: 9 May 2001  

Kjell G. Nyborg

University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); Swiss Finance Institute - Zurich

Ilya A. Strebulaev

Stanford University - Graduate School of Business; National Bureau of Economic Research

Date Written: March 2001

Abstract

The paper models fixed rate tenders, where a central bank offers to lend central bank funds to financial institutions. Bidders are constrained by the amount of collateral they have. We focus on the strategic interaction between bidding in the tender and trading in the interbank market after the tender, where short squeezes could occur. We examine how the design of the tender affects equilibrium bidding behavior and the incidence of short squeezes. Important elements in the analysis include the type of policy implemented by the central bank as well as bidders' initial endowments of liquidity and collateral. Three instruments for softening short squeezes are identified: the tender rate, the tender sizes, and admissible collateral. Increasing the tender rate or size tends to decrease the probability and severity of a short squeeze. The possibility of a short squeeze may induce bidders to oversubscribe even if the tender rate is higher than the competitive rate.

Keywords: Short squeeze, collateral, fixed rate tender, liquidity

JEL Classification: D44, E58, G28

Suggested Citation

Nyborg, Kjell G. and Strebulaev, Ilya A., Collateral and Short Squeezing of Liquidity in Fixed Rate Tenders (March 2001). London Business School Working Paper No. IFA 329. Available at SSRN: https://ssrn.com/abstract=268003 or http://dx.doi.org/10.2139/ssrn.268003

Kjell G. Nyborg (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland
+41 (0)44 634 2980 (Phone)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Swiss Finance Institute - Zurich ( email )

Zurich
Switzerland

Ilya A. Strebulaev

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

HOME PAGE: http://faculty-gsb.stanford.edu/strebulaev/

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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