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Securities market theory: Possession, repo and rehypothecation

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Author Info

  • Bottazzi, Jean-Marc
  • Luque, Jaime
  • Páscoa, Mário R.

Abstract

By introducing repo markets we understand how agents need to borrow issued securities before shorting them: (re)-hypothecation is at the heart of shorting. Non-negative amounts of securities in the box of an agent (amounts borrowed or owned but not lent on) can be sold, and recursive use of securities as collateral allows agents to leverage their positions. A binding box constraint induces a liquidity premium: the repo rate becomes special and the security price higher than expected discounted cash-flows. Existence of equilibrium is guaranteed under limited re-hypothecation, a situation secured by (current or proposed) institutional arrangements.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 147 (2012)
Issue (Month): 2 ()
Pages: 477-500

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Handle: RePEc:eee:jetheo:v:147:y:2012:i:2:p:477-500

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Web page: http://www.elsevier.com/locate/inca/622869

Related research

Keywords: Re-hypothecation; Repo; Leverage; Repo collateral multiplier; Short sale; Issuing; Collateral; Specialness; Security pricing;

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References

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  1. Polemarchakis, H. M. & Ku, Bon-Il, 1990. "Options and equilibrium," Journal of Mathematical Economics, Elsevier, vol. 19(1-2), pages 107-112.
  2. Aloisio Araujo & M�rio Rui P�scoa & Juan Pablo Torres-Mart�nez, 2002. "Collateral Avoids Ponzi Schemes in Incomplete Markets," Econometrica, Econometric Society, vol. 70(4), pages 1613-1638, July.
  3. Markus K. Brunnermeier & Lasse Heje Pedersen, 2007. "Market Liquidity and Funding Liquidity," NBER Working Papers 12939, National Bureau of Economic Research, Inc.
  4. Jordan, Bradford D & Jordan, Susan D, 1997. " Special Repo Rates: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 52(5), pages 2051-72, December.
  5. Jean-Marc Bottazzi, 2002. "Incomplete markets: transverse financial structures," Economic Theory, Springer, vol. 20(1), pages 67-82.
  6. Radner, Roy, 1972. "Existence of Equilibrium of Plans, Prices, and Price Expectations in a Sequence of Markets," Econometrica, Econometric Society, vol. 40(2), pages 289-303, March.
  7. Duffie, Darrell & Garleanu, Nicolae & Pedersen, Lasse Heje, 2002. "Securities lending, shorting, and pricing," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 307-339.
  8. Hart, Oliver D., 1975. "On the optimality of equilibrium when the market structure is incomplete," Journal of Economic Theory, Elsevier, vol. 11(3), pages 418-443, December.
  9. Dimitri Vayanos & Pierre-Olivier Weill, 2007. "A search-based theory of the on-the-run phenomenon," LSE Research Online Documents on Economics 24474, London School of Economics and Political Science, LSE Library.
  10. Debreu, Gerard, 1972. "Smooth Preferences," Econometrica, Econometric Society, vol. 40(4), pages 603-15, July.
  11. Jarrow, Robert A, 1980. " Heterogeneous Expectations, Restrictions on Short Sales, and Equilibrium Asset Prices," Journal of Finance, American Finance Association, vol. 35(5), pages 1105-13, December.
  12. Balasko, Yves & Cass, David, 1989. "The Structure of Financial Equilibrium with Exogenous Yields: The Case of Incomplete Markets," Econometrica, Econometric Society, vol. 57(1), pages 135-62, January.
  13. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-44, September.
  14. Bottazzi, Jean-Marc, 1995. "Existence of equilibria with incomplete markets: The case of smooth returns," Journal of Mathematical Economics, Elsevier, vol. 24(1), pages 59-72.
  15. Araujo, Aloisio & Fajardo, Jose & Pascoa, Mario R., 2005. "Endogenous collateral," Journal of Mathematical Economics, Elsevier, vol. 41(4-5), pages 439-462, August.
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Citations

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Cited by:
  1. Jean-Marc Bottazzi & Jaime Luque & Mario R. Pascoa & Suresh Sundaresan, 2011. "The dollar squeeze of the financial crisis," Economics Working Papers we1139, Universidad Carlos III, Departamento de Economía.
  2. Balasko, Yves & Geanakoplos, John, 2012. "Introduction to general equilibrium," Journal of Economic Theory, Elsevier, vol. 147(2), pages 400-406.
  3. Andrei Kapaev, 2013. "Remark on repo and options," Papers 1311.5211, arXiv.org.
  4. repec:hal:journl:halshs-00673982 is not listed on IDEAS
  5. Jean-Marc Bottazzi & Jaime Luque & Mario R. Pascoa, 2011. "Trading and rational security pricing bubbles," Economics Working Papers we1119, Universidad Carlos III, Departamento de Economía.
  6. Anouk Levels & Jeannette Capel, 2012. "Is Collateral Becoming Scarce? Evidence for the euro area," DNB Occasional Studies 1001, Netherlands Central Bank, Research Department.
  7. Renato Bruni & Francesco Cesarone & Andrea Scozzari & Fabio Tardella, 2012. "A new stochastic dominance approach to enhanced index tracking problems," Economics Bulletin, AccessEcon, vol. 32(4), pages 3460-3470.

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