Rehypothecation and Liquidity

39 Pages Posted: 19 Aug 2015 Last revised: 6 Mar 2019

See all articles by David Andolfatto

David Andolfatto

Simon Fraser University (SFU) - Department of Economics; Federal Reserve Bank of St. Louis

Fernando M. Martin

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Shengxing Zhang

London School of Economics (LSE) - Department of Economics

Date Written: 2015-02-02

Abstract

We develop a dynamic general equilibrium monetary model where a shortage of collateral and incomplete markets motivate the formation of credit relationships and the rehypothecation of assets. Rehypothecation improves resource allocation because it permits liquidity to flow where it is most needed. The liquidity benefits associated with rehypothecation are shown to be more important in high-inflation (high interest rate) regimes. Regulations restricting the practice are shown to have very different consequences depending on how they are designed. Assigning collateral to segregated accounts, as prescribed in the Dodd-Frank Act, is generally welfare-reducing. In contrast, an SEC15c3-3 type regulation can improve welfare through the regulatory premium it confers on cash holdings, which are inefficiently low when interest rates and inflation are high.

Keywords: rehypothecation, money, collateral, credit relationship

JEL Classification: E4, E5

Suggested Citation

Andolfatto, David and Martin, Fernando M. and Zhang, Shengxing, Rehypothecation and Liquidity (2015-02-02). FRB St. Louis Working Paper No. 2015-3. Available at SSRN: https://ssrn.com/abstract=2646142 or http://dx.doi.org/10.20955/wp.2015.003

David Andolfatto (Contact Author)

Simon Fraser University (SFU) - Department of Economics ( email )

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Federal Reserve Bank of St. Louis ( email )

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Fernando M. Martin

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States
314-444-7350 (Phone)

Shengxing Zhang

London School of Economics (LSE) - Department of Economics ( email )

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London WC2A 2AE
United Kingdom

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