Banks are vital suppliers of money-like safe assets, which they produce by issuing short-term liabilities and pledging collateral. But their ability to create safe assets varies over time as leverage constraints fluctuate. Chase Ross, an economist at the Board of Governors of the Federal Reserve System in the Division of Financial Stability, presents a model to describe private safe-asset production when intermediaries face leverage constraints.
He measures bank leverage constraints using bank-intermediated basis trades. The collateral premium — a strategy long Treasuries used more often as repo collateral and short Treasuries used less often — has a positive expected return of 22 basis points per year because the collateral premium compensates for bank leverage risk. He finds that Treasuries used as collateral have higher average returns than Treasuries not used as collateral, even after controlling for observables.