Haircut, Interest Rate, and Collateral Quality in the Tri-Party Repo Market: Evidence and Theory

Sangyup Choi, Inkee Jang, Kee-Youn Kang and Hyunpyung Kim
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Inkee Jang: Department of Economics, The Catholic University of Korea
Kee-Youn Kang: Department of Economics, University of Liverpool
Hyunpyung Kim: Department of Economics, Yonsei University

No 11, Working Papers from University of Liverpool, Department of Economics

Abstract: Leveraging the universe of transaction-level data from the Korean tri-party repo market, we examine how repo contract terms interact with collateral quality. We find that both the haircut and the interest rate increase with collateral risk, consistent with previous findings. However, conditioning on the same collateral quality, we uncover the trade-off between the haircut and the interest rate: A 1% point increase in the interest rate is associated with a 1.3% point reduction in the haircut. Moreover, the rate at which the interest rate substitutes the haircut decreases in market uncertainty, suggesting that the relative importance of insurance instruments increases with default risk. We theoretically show that the interaction between lenders' incentives to acquire information about collateral quality and borrowers' incentives to default opportunistically in a collateralized debt market is key to rationalizing the positive (negative) unconditional (conditional) relationship between the haircut and the interest rate.

Keywords: Repo market; collateralized debt; haircut; collateral quality; costly information acquisition; uncertainty (search for similar items in EconPapers)
JEL-codes: D53 D8 E44 G23 (search for similar items in EconPapers)
Pages: 64 pages
Date: 2024-07
New Economics Papers: this item is included in nep-mac
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Related works:
Working Paper: Haircut, Interest Rate, and Collateral Quality in the Tri-Party Repo Market: Evidence and Theory (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:liv:livedp:202411

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