Liquidating Illiquid Collateral

40 Pages Posted: 11 Dec 2012 Last revised: 10 Dec 2015

See all articles by Martin Oehmke

Martin Oehmke

London School of Economics & Political Science (LSE) - Department of Finance

Date Written: January 17, 2013

Abstract

Defaults of financial institutions can cause large, disorderly liquidations of repo collateral. This paper analyzes the dynamics of such liquidations. The model shows that (i) the equilibrium price of the collateral asset can overshoot; (ii) the creditor structure in repo lending involves a fundamental tradeoff between risk sharing and inefficient 'rushing for the exits' by competing sellers of collateral; (iii) repo lenders should take into account creditor structure, strategic interaction, and their own balance constraints when setting margins; and (iv) the model provides a framework to analyze transfers of repo collateral to 'deep pocket' buyers or a repo resolution authority.

Keywords: Collateral, Liquidation, Repo Market, Illiquidity, Fire Sales, Creditor Structure, Counterparty Risk Management

JEL Classification: G00, G20, G32, G33

Suggested Citation

Oehmke, Martin, Liquidating Illiquid Collateral (January 17, 2013). Journal of Economic Theory (2014), 149: 183-210. Available at SSRN: https://ssrn.com/abstract=2187335 or http://dx.doi.org/10.2139/ssrn.2187335

Martin Oehmke (Contact Author)

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

Register to save articles to
your library

Register

Paper statistics

Downloads
57
Abstract Views
456
rank
371,619
PlumX Metrics