Pricing Repo: a Model of Haircuts and Rates

Abstract

We study the effect of collateral quality on repo rates and haircuts. We build a model of repo, where value-at-risk and expected shortfall arise endogenously as sufficient statistics of the collateral quality, that is, its return distribution. Although a higher expected shortfall increases both haircuts and repo rates, a higher value-at-risk leads to a larger haircut and a lower rate. We confirm our model’s predictions using novel over-the-counter deal-level repo data from Moscow Exchange. Additionally, we empirically document that borrowers’ liquidity needs (and not the borrowers’ credit risk) drive the interchangeability between repo rates and haircuts, consistent with the model.

Keywords: repo, collateral, haircut, repo rate, value-at-risk, expected shortfall

JEL Classification: D83, G23, G32