Staff Reports
Fragility of Safe Asset Markets
Number 1026
July 2022 Revised August 2023

JEL classification: C7, G01, G1, E4, E5

Authors: Thomas M. Eisenbach and Gregory Phelan

In March 2020, safe asset markets experienced surprising and unprecedented price crashes. We explain how strategic investor behavior can create such market fragility in a model with investors valuing safety, investors valuing liquidity, and constrained dealers. While safety investors and liquidity investors can interact symbiotically with offsetting trades in times of stress, liquidity investors’ strategic interaction harbors the potential for self-fulfilling fragility. When the market is fragile, standard flight-to-safety can have a destabilizing effect and trigger a “dash-for-cash” by liquidity investors. Well-designed policy interventions can reduce market fragility ex ante and restore orderly functioning ex post.

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Author Disclosure Statement(s)
Thomas M. Eisenbach and Gregory Phelan
The authors declare that they have no relevant or material financial interests that relate to the research described in this paper.
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