A study proposes endogenous implicit guarantees on risky assets, where government bailouts buy assets to meet private liquidity needs knowledge asymmetry. The government can offset imperfect direct transfers to agents by buying assets, especially when more limited agents are more exposed to an asset. An endogenous implicit guarantee premium allows hazardous assets to be traded as risk-free during anticipated bailouts. This bailout is exacerbated by financial frictions like risk-shifting. The paper also examines how this rescue helps illuminate the euro area’s sovereign debt dilemma.

Image courtesy of interviewee. December 19, 2023