Liquidation Value and Loan Pricing: Evidence From Repo Markets

35 Pages Posted: 16 Jul 2020 Last revised: 5 Aug 2020

See all articles by Francesca Barbiero

Francesca Barbiero

European Central Bank (ECB)

Glenn Schepens

ECB -Financial Research Division

Jean-David Sigaux

European Central Bank (ECB)

Date Written: August 4, 2020

Abstract

We show that the liquidation value of collateral depends on who is pledging it. Using transaction-level data on all overnight repurchase agreements (repo) of 47 large European banks, we find that a loan collateralized by a sovereign bond carries a 3.0 bps rate premium if the borrower is of the same country as the collateral issuer. The main driver of this premium is the decrease in liquidation value which occurs when borrower default risk is negatively correlated with collateral value. Accordingly, we show that repo rates increase in the correlation between the borrower's and the collateral issuer's CDS premia, and are high when the borrower is also the collateral issuer. Our results imply that lenders monitor the correlation between borrower default risk and collateral value, and uncover a channel through which the sovereign-bank nexus impacts funding costs.

Keywords: Liquidation value, collateral, repo, sovereign-bank nexus, sovereign bonds

JEL Classification: G21, G12, E43

Suggested Citation

Barbiero, Francesca and Schepens, Glenn and Sigaux, Jean-David, Liquidation Value and Loan Pricing: Evidence From Repo Markets (August 4, 2020). Available at SSRN: https://ssrn.com/abstract=3633769 or http://dx.doi.org/10.2139/ssrn.3633769

Francesca Barbiero

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Glenn Schepens

ECB -Financial Research Division ( email )

Frankfurt am Main
Germany

Jean-David Sigaux (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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