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Re-use of collateral: Leverage, volatility, and welfare

Johannes Brumm, Michael Grill, Felix Kubler and Karl Schmedders
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Johannes Brumm: Karlsruhe Institute of Technology
Michael Grill: European Central Bank

Review of Economic Dynamics, 2023, vol. 47, 19-46

Abstract: We assess the implications of collateral re-use on leverage, volatility, and welfare within a calibrated infinite-horizon asset-pricing model with heterogeneous agents and disaster shocks. In our model, the ability of agents to reuse frees up collateral that can be used to back more transactions. Re-use thus contributes to the buildup of leverage and significantly increases volatility in financial markets. When introducing limits on re-use, we find that volatility is strictly decreasing as these limits become tighter, yet the impact on welfare is non-monotone. In the model, allowing for some re-use can improve welfare as it enables agents to share risk more effectively. Allowing re-use beyond intermediate levels, however, can lead to excessive leverage and lower welfare. So the analysis in this paper provides a rationale for limiting, yet not banning, re-use in financial markets. (Copyright: Elsevier)

Keywords: Collateral re-use; Disaster shocks; Heterogeneous agents; Leverage; Volatility; Welfare (search for similar items in EconPapers)
JEL-codes: D53 G01 G12 G18 (search for similar items in EconPapers)
Date: 2023
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https://dx.doi.org/10.1016/j.red.2022.03.003
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Working Paper: Re-use of collateral: leverage, volatility, and welfare (2018) Downloads
Working Paper: Re-Use of Collateral: Leverage, Volatility, and Welfare (2017) Downloads
Working Paper: Re-use of Collateral: Leverage, Volatility, and Welfare (2017) Downloads
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DOI: 10.1016/j.red.2022.03.003

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