(In)efficient repo markets

Abstract

Repo markets suffer from funding misallocations and funding runs. In a rollover risk model with collateral, we show how repo trading and clearing mechanisms can resolve these inefficiencies. In over-the-counter markets, non-anonymous trading prevents asset liquidations but causes runs on low-quality borrowers. In central-counterparty markets, anonymous trading provides insurance against small funding shocks but causes inefficient asset liquidations for intermediate funding shocks. The privately optimal market structure requires central clearing with a novel two-tiered guarantee fund to insure against illiquidity and insolvency. Our findings inform the policy debate on funding crises and explain empirical patterns of collateral premia.

Keywords: repo market, funding run, financial stability, asymmetric information, central clearing, novation, guarantee fund, collateral

JEL Classification: G01, G14, G21, G28