Working Paper: NBER ID: w17422
Authors: Jakub W. Jurek; Erik Stafford
Abstract: This paper develops a parsimonious static model for characterizing financing terms in collateralized lending markets. We characterize the systematic risk exposures for a variety of securities and develop a simple indifference-pricing framework to value the systematic crash risk exposure of the collateral. We then apply Modigliani and Miller's (1958) Proposition Two (MM) to split the cost of bearing this risk between the borrower and lender, resulting in a schedule of haircuts and financing rates. The model produces comparative statics and time-series dynamics that are consistent with the empirical features of repo market data, including the dramatic change in financing terms for structured products during the credit crisis of 2007-2008.
Keywords: No keywords provided
JEL Codes: G01; G12; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| systematic crash risk exposure (G01) | financing terms (G32) |
| type of collateral (G21) | cost of capital (G31) |
| market crashes (G01) | financing terms for structured products (G32) |
| systematic risk profiles of structured securities (G12) | expected haircuts and spreads (G12) |
| decline in value of collateral (G33) | adjustment of financing terms (G32) |
| lenders' exposure to crash risk (G21) | likelihood of market failure (D52) |
| market conditions (P42) | dynamics of financing spreads and haircuts (E44) |