Repo Rates and the Collateral Spread Puzzle

58 Pages Posted: 19 Feb 2019 Last revised: 22 Feb 2019

See all articles by Kjell G. Nyborg

Kjell G. Nyborg

University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Multiple version iconThere are 2 versions of this paper

Date Written: February 15, 2019

Abstract

Repo rates frequently exceed unsecured rates in practice. As an explanation, this paper derives a constrained-arbitrage relation between the unsecured rate, the repo rate, and the illiquidity adjusted expected rate of return of the underlying collateral. The theory is based on unsecured borrowing constraints in the market for liquidity. Repos and security cash-market trades are alternative means to get liquidity. Collateral spreads (unsecured less repo rate) can turn negative if borrowing constraints tighten, unsecured rates spike down, or from a depressed and illiquid security market. The constrained-arbitrage theory sheds light on the evolution of collateral spreads over time.

Keywords: collateral spread, constrained-arbitrage, liquidity, market linkages, repo rate, unsecured rate, general collateral

JEL Classification: G01, G12, G21

Suggested Citation

Nyborg, Kjell G., Repo Rates and the Collateral Spread Puzzle (February 15, 2019). Swiss Finance Institute Research Paper No. 19-04, Available at SSRN: https://ssrn.com/abstract=3335203 or http://dx.doi.org/10.2139/ssrn.3335203

Kjell G. Nyborg (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland
+41 (0)44 634 2980 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute

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

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