The Impact of ECB Collateral Eligibility on Bond Yields: Evidence from the German Market

The purpose of the European Central Bank’s (ECB) collateral framework is to define the set of eligible assets (EAs) that financial institutions can use as collateral in central bank credit operations. Marketable eligible assets include for example bank bonds, government bonds, and asset-backed securities. The collateral framework is an important part of the implementation of monetary policy but is still often overlooked in academic research. The theoretical framework suggests that collateral eligibility increases bond prices and lowers yields. Transmission mechanisms through which eligibility may affect yields are pledgeability and haircuts, liquidity, investor demand, and market conditions. Still, empirical evidence of such yield effects remains scarce. This thesis examines whether ECB collateral eligibility affects bond yields in the German market. The main research question asks if eligible bonds trade at different yields than otherwise similar non-eligible bonds under normal market conditions. Two additional questions are considered. The first sub-question examines if the effects of collateral eligibility differ across issuer types like banks and corporations. The second sub-question is motivated by the fact that the importance of collateral framework increases in periods of market stress. Assuming that eligibility effect is more likely to emerge in abnormal markets, this thesis examines if effects of collateral eligibility differ during ECB-defined market stress compared to normal market conditions. This thesis combines a theoretical review with a quantitative empirical analysis. The empirical part of the thesis is done using bond-level regression analysis to test if ECB collateral eligibility has a significant effect on yields. Regression analysis is chosen because it allows to isolate the specific impact of eligibility status while controlling the other determinants of bond yields. To improve comparability, the bond selection aims to ensure that the characteristics of the non-EA bonds are as similar as possible to the eligible ones. Due to the lack of historical price data and the daily updates of ECB list of EAs, the analysis is done using cross-sectional approach. To address the second sub-question, this thesis applies two observation dates representing normal market conditions in 2025 and ECB-defined market stress in 2020. The results show that in 2025, eligible bonds trade at slightly higher yield than comparable non-eligible bonds, which is not what is expected based on the theoretical prediction. The estimated effect of EA status is however very small in economic terms, placing the results close to the research documenting limited or no eligibility effects. When the analysis is done by issuer groups, the positive yield effect remains for banking bonds but disappears for bonds issued by other corporations. The most interesting finding of this thesis relates to the comparison between 2025 normal market conditions and 2020 stressed conditions. In contrast to 2025, the yield effect of collateral eligibility in 2020 sample is negative and economically much more significant. This finding is consistent with the theoretical framework and with ECB evidence showing that the use of central bank credit increased during this period. Moreover, crisis-related changes in the collateral framework likely strengthened the role of EAs. When central bank funding is more needed, the value of EA status increases. Overall, the results suggest that the impact of the collateral framework and the eligibility status of an asset is state-dependent in the financial markets.