Government as a borrower of first resort

Hennessy, C and Chemla, G (2016) Government as a borrower of first resort. Journal of Monetary Economics, 84. pp. 1-16. ISSN 0304-3932

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Optimal government bond supply is examined under asymmetric information and safe asset scarcity. Corporations issue junk debt when demand for safe debt is high since uninformed investors then migrate to risky overheated debt markets. Uninformed demand stimulates informed speculation, driving debt prices toward fundamentals, encouraging pooling at high leverage. As borrower of first resort, government can issue bonds, siphoning off uninformed demand for risky corporate debt, reducing wasteful informed speculation. Government bonds eliminate pooling at high leverage or improve risk sharing in such equilibria. Optimal government bond supply is increasing in demand for safe assets and non-monotonic in marginal Q.

Item Type: Article
Additional Information: © 2016 Elsevier B V
Subjects: I > Investment appraisal
A > Assets
G > Government borrowing
I > Information
R > Risk
Subject Areas: Finance
DOI: 10.1016/j.jmoneco.2016.09.001
Date Deposited: 23 Feb 2017 14:07
Last Modified: 06 Oct 2017 16:50

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