A Portfolio Model of Quantitative Easing

This paper presents a portfolio model of asset price effects arising from central bank large-scale asset purchases, or quantitative easing (QE). Two financial frictions — segmentation of the market for central bank reserves and imperfect asset substitutability — give rise to two distinct portfolio effects. One is well known and derives from the reduced supply of the purchased assets. The other is new, runs through banks’ portfolio responses to reserves expansions, and is independent of the types of assets purchased. The results imply that central bank reserve expansions can affect long-term bond prices even in the absence of long-term bond purchases.