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Re-use of Collateral: Leverage, Volatility, and Welfare

Michael Grill, Karl Schmedders (), Felix Kubler () and Johannes Brumm
Additional contact information
Michael Grill: European Central Bank
Johannes Brumm: University of Zurich

No 697, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: We assess the quantitative implications of the re-use of collateral on financial market leverage, volatility, and welfare within an infinite-horizon asset-pricing model with heterogeneous agents. In our model, the ability of agents to re-use frees up collateral that can be used to back more transactions. Re-use thus contributes to the build-up 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.

New Economics Papers: this item is included in nep-ban, nep-dge and nep-rmg
Date: 2017
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Related works:
Working Paper: Re-use of collateral: leverage, volatility, and welfare (2018) Downloads
Working Paper: Re-Use of Collateral: Leverage, Volatility, and Welfare (2017) Downloads
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