Liquidating illiquid collateral

Martin Oehmke

Journal of Economic Theory, 2014, vol. 149, issue C, 183-210

Abstract: Defaults of financial institutions can cause large, disorderly liquidations of repo collateral. This paper analyzes the dynamics of such liquidations. The model shows that (i) the equilibrium price of the collateral asset can overshoot; (ii) the creditor structure in repo lending involves a fundamental trade-off between risk sharing and inefficient “rushing for the exits” by competing sellers of collateral; (iii) repo lenders should take into account creditor structure, strategic interaction, and their own balance sheet constraints when setting margins; and (iv) the model provides a framework to analyze transfers of repo collateral to “deep-pocket” buyers or a repo resolution authority.

Keywords: Collateral; Liquidation; Repo market; Illiquidity; Fire sales; Creditor structure; Counterparty risk management (search for similar items in EconPapers)
JEL-codes: G00 G20 G32 G33 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:149:y:2014:i:c:p:183-210

DOI: 10.1016/j.jet.2013.02.001

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