Re-use of Collateral: Leverage, Volatility, and Welfare

42 Pages Posted: 20 Dec 2018

See all articles by Johannes Brumm

Johannes Brumm

Karlsruhe Institute of Technology

Michael Grill

European Central Bank (ECB)

Felix Kubler

University of Zurich; Swiss Finance Institute

Karl Schmedders

University of Zurich

Multiple version iconThere are 2 versions of this paper

Date Written: December 19, 2018

Abstract

We assess the quantitative implications of collateral re-use on leverage, volatility, and welfare within an infinite-horizon asset-pricing model with heterogeneous agents. In our model, the ability of agents to reuse frees up collateral that can be used to back more transactions. Re-use thus contributes to the buildup of leverage and significantly increases volatility in financial markets. When introducing limits on re-use, we find that volatility is strictly decreasing as these limits become tighter, yet the impact on welfare is non-monotone. In the model, allowing for some re-use can improve welfare as it enables agents to share risk more effectively. Allowing reuse beyond intermediate levels, however, can lead to excessive leverage and lower welfare. So the analysis in this paper provides a rationale for limiting, yet not banning, re-use in financial markets.

Keywords: heterogeneous agents, leverage, re-use of collateral, volatility, welfare

JEL Classification: D53, G01, G12, G18

Suggested Citation

Brumm, Johannes and Grill, Michael and Kubler, Felix E. and Schmedders, Karl, Re-use of Collateral: Leverage, Volatility, and Welfare (December 19, 2018). ECB Working Paper No. 2218. Available at SSRN: https://ssrn.com/abstract=3304462

Johannes Brumm (Contact Author)

Karlsruhe Institute of Technology ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

Michael Grill

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Felix E. Kubler

University of Zurich ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Karl Schmedders

University of Zurich ( email )

Moussonstrasse 15
Zürich, CH-8044
Switzerland
+41 (0)44 634 3770 (Phone)

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