Haircut Dynamics

Abstract:     
In collateralized lending markets haircuts are used to protect the lender from the risk of loss. An important cross-sectional determinant of haircuts is the systematic risk profile of the collateral, which describes the rate at which the collateral value is expected to decline in adverse market conditions (i.e. when aggregate conditions deteriorate and/or aggregate risk increases). Assets whose value is expected to decline rapidly are predicted to have procyclical and highly volatile haircuts in an efficient market. Our simple 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.

Number of Pages in PDF File: 42

Keywords: Repo, Collateral, Crashes, Financing, Securitized

JEL Classification: G1, G2

working papers series