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Collateral, rehypothecation, and efficiency

Hyejin Park and Charles Kahn ()

Journal of Financial Intermediation, 2019, vol. 39, issue C, 34-46

Abstract: This paper studies rehypothecation, a practice in which financial institutions re-pledge collateral pledged to them by their clients. Rehypothecation enhances provision of funding liquidity to the economy, but it also incurs deadweight cost by misallocating the asset among the agents when counterparties fail. We examine the possibility of a conflict between the intermediary and its borrower on rehypothecation arrangements. The direction of this conflict depends on haircuts of the contract between them: if the contract involves over-collateralization, there tends to be an excessive use of rehypothecation, and if the contract involves under-collateralization, there tends to be an insufficient use of rehypothecation. This offers an empirical prediction of a link between the size of haircut in collateralized financial contracts, borrower information, and the likelihood of rehypothecation.

Keywords: Collateral; Rehypothecation; Moral hazard; Misallocation (search for similar items in EconPapers)
JEL-codes: D53 D62 G21 G28 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1016/j.jfi.2018.06.001

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