Fire Buys of Collateral Assets

When central banks provide unlimited liquidity, eligible collateral assets become more valuable for banks with greater need of liquidity. Since eligible collateral assets are traded over the counter, banks that are more dependent on central bank funding face price discrimination and incur the fire buy premium. Because the risk-shifting channel is open, banks pay a higher premium for lower-rated collateral assets. Using the full fixed-income trading book of German banks, I identify each trade of each bank and investigate how unlimited liquidity provisions affect prices. Expenditures with the fire-buy premium amounted to, on average, 3.2% of banks' balance sheets