Central bank liquidity facilities and market making

Central banks have used asset purchase programs to keep markets operational in times of crisis. We model how central bank asset purchases alleviate dealers' balance-sheet constraints, preventing markets from becoming one sided, improving price efficiency and reducing dealer risk positions. Central banks can fully alleviate dealers' balance-sheet constraints by purchasing assets at their fair value; an action which maximizes welfare when dealers are competitive. However, when there is imperfect competition amongst dealers, a central bank which bears costs from intervening may only purchase assets at a discount. We offer additional analysis on the role of lending programs when dealers have leverage constraints, dealers who are unable to net out all balance sheet costs, and cross-asset impacts from interventions.