Research
Working papers
The Price of Money: The Reserves Convertibility Premium over the Term Structure
With Kjell G. Nyborg
CEPR Discussion Paper DP18371, July 2023
Central-bank money provides utility by serving as means of exchange for virtually all transactions in the economy. New reserves (money) are issued to banks in exchange for collateral such as government bonds. An asset’s degree of direct convertibility into fresh reserves may affect its utility and, consequently, its market price. We show the existence of a government-bond reserves convertibility premium, which tapers off at longer maturities. Essentially, there is a pure monetary component to some asset prices. Our findings have implications for our understanding of liquidity premia, the term structure of interest rates, and the impact of central-bank collateral policy.
(An earlier version circulated under the title “The price of money: How collateral policy affects the yield curve”)
Robust difference-in-differences analysis when there is a term structure
With Kjell G. Nyborg
Working paper, August 2023
It is common practice in finance to use difference-in-differences analysis to examine fixed-income pricing data. This paper uses simulations to show that this method applied to pricing variables that exhibit a term structure, such as yields or credit spreads, systematically produces false and mismeasured treatment effects. This holds true even if the treatment is randomly assigned. False and mismeasured treatment effects result from heterogeneous effects in different parts of the term structure in combination with unequal distributions of residual maturities in the treated and control bond samples. Neither bond fixed effects nor explicit yield-curve control in the specification resolve the issues. By combining difference-in-differences analysis with yield-curve modeling this paper provides new methodology to overcome these issues.
Collateral, Central Bank Repos, and Systemic Arbitrage
With Falko Fecht, Kjell G. Nyborg, and Jörg Rocholl
Swiss Finance Institute Research Paper Series No. 16-66, November 2016
(under revision, new version coming soon)
Central banks are under increased scrutiny because of the rapid growth in, and composition of, their balance sheets. Therefore, understanding the processes that shape these balance sheets and their consequences is crucial. We contribute by studying an extensive dataset of banks’ liquidity uptake and pledged collateral in central bank repos. We document systemic arbitrage whereby banks funnel credit risk and low-quality collateral to the central bank. Weaker banks use lower quality collateral to demand disproportionately larger amounts of central bank money (liquidity). This holds both before and after the financial crisis and may contribute to financial fragility and fragmentation.
Central bank liquidity policy and the cross-section of bank equity returns
September 2022
This paper examines abnormal bank equity returns around the announcement and implementations of the largest central bank liquidity operations to date. Those were conducted by the European Central Bank (ECB) at the height of the sovereign debt crisis in 2011 and 2012. I find that banks in countries perceived as being relatively riskier at the time experienced larger positive abnormal equity returns. Relating country-level abnormal returns to country-level liquidity uptake shows that banks with higher liquidity uptake profit disproportionately more from larger returns over this period. This provides evidence that the ECB alleviates stress in the euro area through the provisioning of relatively more liquidity to banks in riskier countries.
Long-term Central Bank Repos and Bank Rollover Risk
December 2017
Over a period of more than four years the ECB has repeatedly and in addition to its standard monetary refinancing operations offered repos with extraordinarily long durations. This paper argues that such operations serve the function of reducing rollover risks for Eurozone banks. The data shows that high rollover (and borrowing) costs of banks in struggling countries correlate with the ECB’s offering periods of these additional longer-dated repos. Banks with high rollover costs take disproportionately more Eurosystem liquidity and profit, ex-post, exceptionally from market borrowing cost reductions. As discussed, sheltering banks from rollover risks prevents some banks’ equity holders (possibly erroneously) from deciding to let the bank default on its obligations. Moreover, such measures neither solve bank debt overhang (Myers, 1977) nor do they bail out banks efficiently (Bhattacharya and Nyborg, 2013). The inefficiency feature may have implications for the observed increase in fragmentation in the Euro area, the bank-sovereign nexus, and the risk composition of the ECB’s balance sheet.