The Paradox of Conservative Haircuts

73 Pages Posted: 9 Feb 2023 Last revised: 8 Jan 2024

See all articles by Dmitry Chebotarev

Dmitry Chebotarev

Indiana University - Kelley School of Business - Department of Finance

Date Written: December 18, 2022

Abstract

Collateral requirements affect counterparty selection. I show empirically that conservative Central Counterparty (CCP) repo haircuts push low-risk borrowers away from the CCP and into the over-the-counter (OTC) repo market. When a CCP increases repo haircuts, its policy change applies to all participants uniformly but most strongly affects borrowers whose funding constraints are binding. Affected borrowers with high credit ratings are more likely to switch to borrowing over the counter due to the risk preferences of OTC repo lenders. As a result, conservatively high haircuts induce negative selection in the CCP repo market, potentially threatening its stability.

Keywords: CCP, Central Counterparties, OTC, Haircut, Collateral Requirements, Repo

JEL Classification: G21, G23, G28, G32

Suggested Citation

Chebotarev, Dmitry, The Paradox of Conservative Haircuts (December 18, 2022). Available at SSRN: https://ssrn.com/abstract=4350984 or http://dx.doi.org/10.2139/ssrn.4350984

Dmitry Chebotarev (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

HOME PAGE: http://https://dchebotarev.com/

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