Abstract
Central banks have used asset purchase programs to keep markets operational in times of crisis. We model how central bank asset purchases alleviate dealers' balance-sheet constraints, preventing markets from becoming one sided, improving price efficiency and reducing dealer risk positions. Central banks can fully alleviate dealers' balance-sheet constraints by purchasing assets at their fair value; an action which maximizes welfare when dealers are competitive. However, when there is imperfect competition amongst dealers, a central bank which bears costs from intervening may only purchase assets at a discount. We offer additional analysis on the role of lending programs when dealers have leverage constraints, dealers who are unable to net out all balance sheet costs, and cross-asset impacts from interventions.
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