The Collateral Premium and Levered Safe-Asset Production
62 Pages Posted: 21 Jul 2022
Date Written: July 1, 2022
Banks are vital suppliers of money-like safe assets, which they produce by issuing short-term liabilities and pledging collateral. But their ability to create safe assets varies over time as leverage constraints fluctuate. I present a model to describe private safe-asset production when intermediaries face leverage constraints. I measure bank leverage constraints using bank-intermediated basis trades. The collateral premium—a strategy long Treasuries used more often as repo collateral and short Treasuries used less often—has a positive expected return of 22 basis points per year because the collateral premium compensates for bank leverage risk.
Keywords: Collateral, Bank leverage constraints, Repurchase agreement, Safe asset, Money
JEL Classification: E40, E51, G12, G20
Suggested Citation: Suggested Citation