Lender of Last Resort, Buyer of Last Resort, and a Fear of Fire Sales in the Sovereign Bond Market

67 Pages Posted: 12 Apr 2016 Last revised: 28 Dec 2020

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Diane Pierret

Universite du Luxembourg - Luxembourg School of Finance; Centre for Economic Policy Research (CEPR)

Sascha Steffen

Frankfurt School of Finance & Management; Centre for Economic Policy Research (CEPR)

Date Written: December 23, 2020

Abstract

We document the mechanism through which the risk of fire sales in the sovereign bond market contributed to the effectiveness of two major central bank interventions designed to restore financial stability during the European sovereign debt crisis. As a lender of last resort via the long-term refinancing operations (LTROs), the European Central Bank (ECB) improved the collateral value of sovereign bonds of peripheral countries. This resulted in an elevated concentration of these bonds in the portfolios of domestic banks, increasing fire-sale risk and making both banks and sovereign bonds riskier. In contrast, the ECB’s announcement of being a potential buyer of last resort via the Outright Monetary Transaction (OMT) program attracted new investors and reduced fire-sale risk in the sovereign bond market.

Keywords: Bank-sovereign nexus, ECB, financial stability, unconventional monetary policy

JEL Classification: G01, G21, G28

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Pierret, Diane and Steffen, Sascha, Lender of Last Resort, Buyer of Last Resort, and a Fear of Fire Sales in the Sovereign Bond Market (December 23, 2020). ZEW - Centre for European Economic Research Discussion Paper No. 16-019, Swiss Finance Institute Research Paper No. 18-35, Available at SSRN: https://ssrn.com/abstract=2762265 or http://dx.doi.org/10.2139/ssrn.2762265

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States
2129980354 (Phone)
2129954256 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~vacharya

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Diane Pierret

Universite du Luxembourg - Luxembourg School of Finance ( email )

162a, avenue de la Faïencerie
Luxembourg-Limpertsberg, L-1511
Luxembourg

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Sascha Steffen (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee
32-34
Frankfurt, 60322
Germany
16097326929 (Phone)

HOME PAGE: http://www.sascha-steffen.de

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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