Crashes and Collateralized Lending

Jakub W. Jurek and Erik Stafford

No 17422, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper develops a parsimonious static model for characterizing financing terms in collateralized lending markets. We characterize the systematic risk exposures for a variety of securities and develop a simple indifference-pricing framework to value the systematic crash risk exposure of the collateral. We then apply Modigliani and Miller's (1958) Proposition Two (MM) to split the cost of bearing this risk between the borrower and lender, resulting in a schedule of haircuts and financing rates. The model produces comparative statics and time-series dynamics that are consistent with the empirical features of repo market data, including the dramatic change in financing terms for structured products during the credit crisis of 2007-2008.

JEL-codes: G01 G12 G2 (search for similar items in EconPapers)
Date: 2011-09
New Economics Papers: this item is included in nep-ban
Note: AP CF
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Citations: View citations in EconPapers (3)

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