Interest Spreads and Margins in Collateral Equilibrium with Heterogeneous Beliefs

26 Pages Posted: 19 Aug 2022

See all articles by Robert Barsky

Robert Barsky

Research Department, Federal Reserve Bank of Chicago; University of Michigan at Ann Arbor - Department of Economics; National Bureau of Economic Research (NBER)

Avery Bogus

Uptake Technologies, Inc.

Matthew Easton

Federal Reserve Bank of Chicago

Date Written: August 18, 2022

Abstract

There continues to be substantial interest in models combining heterogeneous beliefs about asset values with leverage generated by loans from pessimists to the optimistic natural buyers of the asset. This paper determines the size of the interest spread and margin on the loan as a function of the downside risk perceived by the lender, and the amount of risk capital put forward by the borrower. We show that in a continuous state version of a model of collateral equilibrium with high initial leverage, most of the burden of adjustment to increases in such risk are borne by an increase in the interest spread and not the margin or 'haircut'. This is contrary both to the predictions of the much-discussed binomial asset pricing model and the stylized facts in empirical data from the bilateral repo market.

Keywords: Financial Economics, Leverage, Interest Rates, Credit Markets, Heterogeneous Beliefs

JEL Classification: D53, E4, E44, G0, G01, G02, G1, G10

Suggested Citation

Barsky, Robert B. and Bogus, Avery and Easton, Matthew, Interest Spreads and Margins in Collateral Equilibrium with Heterogeneous Beliefs (August 18, 2022). FRB of Chicago Working Paper No. 2022-36, Available at SSRN: https://ssrn.com/abstract=4194151 or http://dx.doi.org/10.2139/ssrn.4194151

Robert B. Barsky (Contact Author)

Research Department, Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States
734-764-9476 (Phone)
734-764-2769 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Avery Bogus

Uptake Technologies, Inc.

Matthew Easton

Federal Reserve Bank of Chicago

230 South LaSalle Street
Chicago, IL 60604
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
10
Abstract Views
118
PlumX Metrics