collateral to support arbitrage trades. We show that with volatile asset demands, arbitrage becomes risky. With information … frictions, a looser collateral policy might render the economy more vulnerable to extremely large demand shocks, while a tighter … collateral constraint helps maintain the stability at the cost of market liquidity supply …

financial frictions and labor demand, as in Jermann and Quadrini (2012), is key to the result. A collateral constraint a la …