Crashes and Collateralized Lending

Jakub W. Jurek, Erik Stafford

NBER Working Paper No. 17422
Issued in September 2011
NBER Program(s):   AP   CF

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.

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Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w17422

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