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Collateral Re-use, Liquidity and Financial Stability

Author

Listed:
  • Matteo Accornero

    (Department of Social Sciences and Economics, Sapienza University of Rome)

Abstract

This work provides a model where the repercussions on financial stability of collateral re-use in repo contracts can be analysed and assessed. In the model, the rationale for repo contracts is the arbitrage activity of a leveraged hedge fund, which is profitably financed by a dealer bank. Repo contracts, in connection with collateral re-use, lubricate both the credit and the financial system, increasing the financial operators’ profits and improving equilibrium rates and volumes. At the same time, they amplify the leverage of the whole economy, making it vulnerable to shocks. Introducing a default risk for the hedge fund, the proposed model identifies diverging effects of collateral re-use on financial stability. In states with low dealer bank profitability, the increase in collateral re-use renders a sound dealer bank management style the profit maximising strategy. Where an unsound balance sheet expansion is highly profitable, the increase in collateral re-use provides destabilising incentives to the dealer bank.

Suggested Citation

  • Matteo Accornero, 2020. "Collateral Re-use, Liquidity and Financial Stability," Working Papers 10/20, Sapienza University of Rome, DISS.
    • Handle: RePEc:saq:wpaper:10/20
    as

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    File URL: http://www.diss.uniroma1.it/sites/default/files/allegati/DiSSE_Accornero_wp10_2020.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    repo markets; collateral re-use; rehypothecation; systemic risk;
    All these keywords.

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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