Collateral Framework: Liquidity Premia and Multiple Equilibria

34 Pages Posted: 20 Apr 2021 Last revised: 7 Aug 2021

See all articles by Yvan Lengwiler

Yvan Lengwiler

University of Basel - Faculty of Business and Economics (WWZ)

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Asia School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: April 16, 2021

Abstract

Central banks normally accept debt of their own governments as collateral in liquidity operations without reservations. This gives rise to a valuable liquidity premium that reduces the cost of government finance. The ECB is an interesting exception in this respect. It relies on external assessments of the creditworthiness of its member states, such as credit ratings, to determine eligibility and the haircut it imposes on such debt. We show how such features in a central bank's collateral framework can give rise to cliff effects and multiple equilibria in bond yields and increase the vulnerability of governments to external shocks. This can potentially induce sovereign debt crises and defaults that would not otherwise arise.

Keywords: Monetary policy, government finance, yields, liquidity premium, default premium, collateral, cliff effect, multiple equilibria

JEL Classification: E58, E62, E43

Suggested Citation

Lengwiler, Yvan and Orphanides, Athanasios, Collateral Framework: Liquidity Premia and Multiple Equilibria (April 16, 2021). MIT Sloan Research Paper No. 6428-21, Available at SSRN: https://ssrn.com/abstract=3828102 or http://dx.doi.org/10.2139/ssrn.3828102

Yvan Lengwiler

University of Basel - Faculty of Business and Economics (WWZ) ( email )

Peter Merian-Weg 6
PO Box
Basel, CH-4002
Switzerland
+41 61 267 3369 (Phone)

HOME PAGE: http://wwz.unibas.ch/lengwiler

Athanasios Orphanides (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=54058

Asia School of Business ( email )

Jalan Kuching, Kuala Lumpur, Wilayah Persekutuan K
Kuala Lumpur, MA
Malaysia

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