Safe Assets and the Evolution of Financial Information

Assets that are perceived as “safe” play a vital role in financial markets, serving, in particular, as high-quality collateral for transactions in repo and OTC derivative markets. The global financial crisis and the problems in Europe have raised concerns that ongoing imbalances in the demand and supply of safe assets could have unhappy consequences for global financial stability and macroeconomic prospects. Although considerable attention has been devoted to studying the macroeconomics of “safe asset shortages,” the way in which perceptions of safe asset status evolve among financial market participants remains poorly understood. The prevailing view is that safe assets are somehow “information insensitive” or “money-like,” meaning they are able to be passed between investors without due diligence. But such analyses do not consider either (a) how the interplay between the structure of trading relationships in financial markets and endogenous information acquisition about underlying collateral affects the equilibrium price of safe assets; or (b) how the evolutionary dynamics of financial information transfer influences that equilibrium. This project uses insights from the literature on the evolution of language, which enables a concrete understanding of the length and syntax of high-fidelity collateral chains.