Crashes and Collateralized Lending

45 Pages Posted: 21 Sep 2011

See all articles by Jakub W. Jurek

Jakub W. Jurek

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Erik Stafford

Harvard Business School - Finance Unit

Multiple version iconThere are 2 versions of this paper

Date Written: September 2011

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.

Suggested Citation

Jurek, Jakub W. and Stafford, Erik, Crashes and Collateralized Lending (September 2011). NBER Working Paper No. w17422. Available at SSRN: https://ssrn.com/abstract=1931193

Jakub W. Jurek (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-1588 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Erik Stafford

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-8064 (Phone)
617-496-7357 (Fax)

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