Lender of Last Resort, Buyer of Last Resort, and a Fear of Fire Sales in the Sovereign Bond Market

We document the mechanism through which the risk of fire sales in the sovereign bond market contributed to the effectiveness of two major central bank interventions designed to restore financial stability during the European sovereign debt crisis. As a lender of last resort via the long-term refinancing operations (LTROs), the European Central Bank (ECB) improved the collateral value of sovereign bonds of peripheral countries. This resulted in an elevated concentration of these bonds in the portfolios of domestic banks, increasing fire-sale risk and making both banks and sovereign bonds riskier. In contrast, the ECB’s announcement of being a potential buyer of last resort via the Outright Monetary Transaction (OMT) program attracted new investors and reduced fire-sale risk in the sovereign bond market.


Presented at:

• ASSA 2017 in Chicago (Jan 2017)

• 4th International Conference on Sovereign Bond Markets in Singapore (Apr 2017)

• SFS Cavalcade in New Haven (May 2018)

• EEA Annual Meeting in Cologne (Aug 2018)

• ECB Workshop on Money Markets and Central Bank Balance Sheets in Frankfurt (Nov 2018)