Citation

Discussion Paper Details

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Title: Government as Borrower of First Resort

Author(s): Gilles Chemla and Christopher Hennessy

Publication Date: June 2016

Keyword(s): asymmetric information, corporate debt markets, governmet debt, issuers, speculators and uninformed investors

Programme Area(s): Financial Economics, Industrial Organization and Public Economics

Abstract: We examine optimal provision of riskless government bonds under asymmetric information and safe asset scarcity. Paradoxically, corporations have incentives to issue junk debt precisely when intrinsic demand for safe debt is high since uninformed investors then migrate to risky overheated debt markets. Uninformed demand stimulates informed speculation which drives junk debt prices closer to fundamentals, encouraging pooling at high leverage. Acting as borrower of first resort, the government can issue safe bonds which siphon off uninformed demand for risky corporate debt and reduce socially wasteful informed speculation. Thus, government bonds either eliminate pooling at high leverage or improve risk sharing in such equilibria. The optimal quantity of government bonds is increasing in intrinsic demand for safe assets and non-monotonic in marginal Q.

For full details and related downloads, please visit: https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11362

Bibliographic Reference

Chemla, G and Hennessy, C. 2016. 'Government as Borrower of First Resort'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11362