Liquidity, Collateral Quality and Interest Rate

Jung-Hyun Ahn, Vincent Bignon, Breton, Régis and Antoine Martin

No 19901, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper analyzes how collateral quality shocks affect banks’ liquidity management and the risk-free rate. We develop a model where banks manage liquidity through near-cash assets and marketable securities subject to idiosyncratic and/or aggregate shocks. Collateral quality deterioration leads to non-monotonic changes in liquidity holdings: moderate declines reduce cash holdings via lower market returns, while severe declines cause precautionary hoarding and market freezes. Reduced collateral quality depresses the risk-free rate. Policy interventions, including liquidity regulation and negative interest rate policies can mitigate these effects. Our findings highlight the risks of collateral quality shocks and the importance of policy complementarities in addressing liquidity issues.

Keywords: Interbank market; Risk-free rate; Collateral; Liquidity regulation; Negative interest rate policy; Cash hoarding (search for similar items in EconPapers)
JEL-codes: E58 G21 G28 (search for similar items in EconPapers)
Date: 2025-01
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Working Paper: Liquidity, Collateral Quality and Interest Rate (2025)
Working Paper: Liquidity, Collateral Quality and Interest Rate (2025)
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