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Fragility of Safe Asset Markets

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Abstract

In March 2020, safe asset markets experienced surprising and unprecedented price crashes. We explain how strategic investor behavior can create such market fragility in a model with investors valuing safety, investors valuing liquidity, and constrained dealers. While safety investors and liquidity investors can interact symbiotically with offsetting trades in times of stress, liquidity investors’ strategic interaction harbors the potential for self-fulfilling fragility. When the market is fragile, standard flight-to-safety can have a destabilizing effect and trigger a “dash-for-cash” by liquidity investors. Well-designed policy interventions can reduce market fragility ex ante and restore orderly functioning ex post.

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  • Thomas M. Eisenbach & Gregory Phelan, 2022. "Fragility of Safe Asset Markets," Staff Reports 1026, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:94496
    Note: Revised October 2024.
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    1. Cimon, David A. & Walton, Adrian, 2024. "Central bank liquidity facilities and market making," Journal of Banking & Finance, Elsevier, vol. 162(C).

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    More about this item

    Keywords

    safe assets; liquidity shocks; global games; Treasury securities; COVID-19;
    All these keywords.

    JEL classification:

    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G01 - Financial Economics - - General - - - Financial Crises
    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services

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