Financial Fragility with Collateral Circulation

55 Pages Posted: 11 Feb 2021

See all articles by Piero Gottardi

Piero Gottardi

University of Essex - Department of Economics; European University Institute - Department of Economics; Ca Foscari University of Venice - Dipartimento di Economia; CESifo (Center for Economic Studies and Ifo Institute)

Vincent Maurin

Swedish House of Finance

Cyril Monnet

University of Bern

Date Written: February 2021

Abstract

We present a model of secured credit chains in which the circulation of risky collateral generates fragility. An intermediary stands between a borrower and a financier. The intermediary borrows to finance her own investment opportunity, subject to a moral hazard problem, and in addition, can intermediate funds. She will only do so if she can repledge to the financier the collateral pledged by the borrower. We show that when the repledged collateral is sufficiently risky and the loan that it secures is recourse, the circulation of collateral generates fragility in the chain, by undermining the intermediary's incentives. The arrival of news about the value of the repledged collateral further increases fragility. This fragility channel of collateral re-use generates a premium for safe or opaque collateral. The environment considered in our model applies to various situations, such as trade credit chains, securitization and repo markets.

JEL Classification: G23, G30

Suggested Citation

Gottardi, Piero and Maurin, Vincent and Monnet, Cyril, Financial Fragility with Collateral Circulation (February 2021). CEPR Discussion Paper No. DP15757, Available at SSRN: https://ssrn.com/abstract=3783983

Piero Gottardi (Contact Author)

University of Essex - Department of Economics ( email )

Wivenhoe Park
Colchester CO4 3SQ
United Kingdom

European University Institute - Department of Economics ( email )

Villa Schifanoia
133 via Bocaccio
Firenze (Florence), Tuscany 50014
Italy

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy
+39 041 257 4192 (Phone)
+39 041 257 4176 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Vincent Maurin

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Cyril Monnet

University of Bern ( email )

Gesellschaftsstrasse 49
Bern, BERN 3001
Switzerland

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