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

77 Pages Posted: 12 Apr 2016 Last revised: 18 Sep 2018

Viral V. Acharya

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

Diane Pierret

HEC - University of Lausanne; Swiss Finance Institute

Sascha Steffen

Frankfurt School of Finance & Management

Date Written: September 15, 2018

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 Pierret, Diane and Steffen, Sascha, Lender of Last Resort, Buyer of Last Resort, and a Fear of Fire Sales in the Sovereign Bond Market (September 15, 2018). 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 - Leonard N. Stern School of Business ( email )

44 West 4th Street
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

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

Diane Pierret

HEC - University of Lausanne ( email )

Institute of Banking and Finance
Unil Dorigny, Batiment Extranef
Lausanne, 1015
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Sascha Steffen (Contact Author)

Frankfurt School of Finance & Management ( email )

Sonnemannstr. 9 -11
Frankfurt, 60314
Germany

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

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