The (Unintended?) Consequences of the Largest Liquidity Injection Ever by Matteo Crosignani et al. (2017), FRB St Louis WP
We study the design of lender of last resort interventions and show that the provision of long-term liquidity incentivizes purchases of high-yield short-term securities by banks. Using a unique security-level data set, we find that the European Central Bank’s three-year Long-Term Refinancing Operation caused Portuguese banks to purchase short-term domestic government bonds that could be pledged to obtain central bank liquidity. This “collateral trade” effect is large, as banks purchased short-term bonds equivalent to 10.6% of amounts outstanding. The steepening of peripheral sovereign yield curves after the policy announcement is consistent with the equilibrium effects of the collateral trade.
Link to full paper: https://files.stlouisfed.org/files/htdocs/wp/2017/2017-039.pdf