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

Johannes Brumm, Michael Grill, Felix Kubler () and Karl Schmedders

No 2218, Working Paper Series from European Central Bank

Abstract: We assess the quantitative implications of collateral re-use on leverage, volatility, and welfare within an infinite-horizon asset-pricing model with heterogeneous agents. 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. JEL Classification: D53, G01, G12, G18

Keywords: heterogeneous agents; leverage; re-use of collateral; volatility; welfare (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-dge and nep-rmg
Date: 2018-12
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Related works:
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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