Repo Markets, Counterparty Risk, and the 2007/2008 Liquidity Crisis

48 Pages Posted: 4 Jul 2008  

Christian Ewerhart

University of Zurich - Department of Economics

Jens Tapking

European Central Bank (ECB)

Date Written: June 23, 2008

Abstract

A standard repurchase agreement between two counterparties is considered to examine the endogenous choice of collateral, the feasibility of secured lending, and welfare implications of the central bank's collateral framework. As an innovation, we allow for two-sided counterparty risk. In line with empirical observations, it is shown that the most liquid and least risky assets are used as collateral in market transactions first. An endogenous opportunity cost arises from using liquid collateral with the central bank. Conditions are identified such that expected utility increases for all market participants when the central bank accepts a broader range of assets as collateral.

Keywords: counterparty risk, repurchase agreements, collateral, liquidity, haircuts

JEL Classification: G21, E51

Suggested Citation

Ewerhart, Christian and Tapking, Jens, Repo Markets, Counterparty Risk, and the 2007/2008 Liquidity Crisis (June 23, 2008). ECB Working Paper No. 909; Swiss Finance Institute Research Paper No. 08-24. Available at SSRN: https://ssrn.com/abstract=1138609

Christian Ewerhart (Contact Author)

University of Zurich - Department of Economics ( email )

Winterthurerstrasse 30
CH-8006 Zurich
Switzerland

Jens Tapking

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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