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Re-use of collateral: Leverage, volatility, and welfare


Brumm, Johannes; Kübler, Felix; Grill, Michael; Schmedders, Karl (2017). Re-use of collateral: Leverage, volatility, and welfare. Swiss Finance Institute Research Paper 17-04, University of Zurich.

Abstract

We assess the quantitative implications of the re-use of collateral on financial market leverage, volatility, and welfare within an infinite-horizon asset-pricing model with heterogeneous agents. In our model, the ability of agents to re-use frees up collateral that can be used to back more transactions. Re-use thus contributes to the build-up of leverage and significantly increases volatility in financial markets. When introducing limits on re-use, we find that volatility is strictly decreasing as these limits become tighter, yet the impact on welfare is non-monotone. In the model, allowing for some re-use can improve welfare as it enables agents to share risk more effectively. Allowing reuse beyond intermediate levels, however, can lead to excessive leverage and lower welfare. So the analysis in this paper provides a rationale for limiting, yet not banning, re-use in financial markets.

Abstract

We assess the quantitative implications of the re-use of collateral on financial market leverage, volatility, and welfare within an infinite-horizon asset-pricing model with heterogeneous agents. In our model, the ability of agents to re-use frees up collateral that can be used to back more transactions. Re-use thus contributes to the build-up of leverage and significantly increases volatility in financial markets. When introducing limits on re-use, we find that volatility is strictly decreasing as these limits become tighter, yet the impact on welfare is non-monotone. In the model, allowing for some re-use can improve welfare as it enables agents to share risk more effectively. Allowing reuse beyond intermediate levels, however, can lead to excessive leverage and lower welfare. So the analysis in this paper provides a rationale for limiting, yet not banning, re-use in financial markets.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:21 April 2017
Deposited On:08 Sep 2017 11:47
Last Modified:29 Jul 2018 04:40
Series Name:Swiss Finance Institute Research Paper
Number of Pages:29
OA Status:Green
Free access at:Official URL. An embargo period may apply.
Official URL:https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2912799
Related URLs:http://sfi.ch/research/publications (Organisation)
Other Identification Number:merlin-id:14755

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