Staff Reports
Fragility of Safe Asset Markets
Number 1026
July 2022

JEL classification: C7, G01, G1, E4, E5

Authors: Thomas M. Eisenbach and Gregory Phelan

We model a safe asset market 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, we show that liquidity investors’ strategic interaction harbors the potential for self-fulfilling fragility. Surprisingly, standard flight to safety in times of stress can have a destabilizing effect and trigger a dash for cash by liquidity investors. This explains how safe asset markets can experience price crashes, as in March 2020. The announcement and execution of policy interventions play important roles for the functioning of safe asset markets.

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AUTHOR DISCLOSURE STATEMENT(S)
Thomas M. Eisenbach and Gregory Phelan
The authors declare that they have no relevant or material financial interests that relate to the research described in this paper.
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