Fragility of Safe Asset Markets

Thomas Eisenbach and Gregory Phelan

No 1026, Staff Reports from Federal Reserve Bank of New York

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.

Keywords: safe assets; liquidity shocks; global games; Treasury securities; COVID-19 (search for similar items in EconPapers)
JEL-codes: C7 E4 E5 G01 G1 G2 (search for similar items in EconPapers)
Pages: 73
Date: 2022-07-01
New Economics Papers: this item is included in nep-ban and nep-gth
Note: Revised October 2024.
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Citations: View citations in EconPapers (1)

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