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Collateral-Motivated Financial Innovation

Author

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  • Ji Shen
  • Hongjun Yan
  • Jinfan Zhang

Abstract

Collateral frictions have a profound effect on our economic landscape, ranging from the design of financial securities, laws, and institutions, to various rules and regulations. We analyze a model with disagreement, where securities and collateral requirements are endogenous. It shows that the security that isolates the variable with disagreement is "optimal" in the sense that alternative securities cannot generate any trading. In an economy with N states, investors may introduce more than N securities, and markets are still incomplete. The model has several novel predictions on the behavior of basis—the spread between the prices of an asset and its replicating portfolio.

Suggested Citation

  • Ji Shen & Hongjun Yan & Jinfan Zhang, 2014. "Collateral-Motivated Financial Innovation," The Review of Financial Studies, Society for Financial Studies, vol. 27(10), pages 2961-2997.
    • Handle: RePEc:oup:rfinst:v:27:y:2014:i:10:p:2961-2997.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhu036
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    Citations

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    Cited by:

    1. Feixue Gong & Gregory Phelan, 2023. "Collateral constraints, tranching, and price bases," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 75(2), pages 317-340, February.
    2. Wei Xiong, 2013. "Bubbles, Crises, and Heterogeneous Beliefs," NBER Working Papers 18905, National Bureau of Economic Research, Inc.
    3. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    4. Denis Gromb & Dimitri Vayanos, 2018. "The Dynamics of Financially Constrained Arbitrage," Journal of Finance, American Finance Association, vol. 73(4), pages 1713-1750, August.
    5. Oehmke, Martin & Zawadowski, Adam, 2015. "Synthetic or real? The equilibrium effects of credit default swaps on bond markets," LSE Research Online Documents on Economics 84511, London School of Economics and Political Science, LSE Library.
    6. Botond Koszegi & Peter Kondor, 2015. "Cursed financial innovation," 2015 Meeting Papers 1098, Society for Economic Dynamics.
    7. Beetsma, Roel & Giuliodori, Massimo & Hanson, Jesper & de Jong, Frank, 2018. "Bid-to-cover and yield changes around public debt auctions in the euro area," Journal of Banking & Finance, Elsevier, vol. 87(C), pages 118-134.
    8. Chan, Ka Kei & Kolokolova, Olga & Lin, Ming-Tsung & Poon, Ser-Huang, 2023. "Price convergence between credit default swap and put option: New evidence," Journal of Empirical Finance, Elsevier, vol. 72(C), pages 188-213.
    9. Markus K. Brunnermeier & Alp Simsek & Wei Xiong, 2014. "A Welfare Criterion For Models With Distorted Beliefs," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 129(4), pages 1753-1797.
    10. Wei Jiang & Jitao Ou & Zhongyan Zhu, 2021. "Mutual Fund Holdings of Credit Default Swaps: Liquidity, Yield, and Risk," Journal of Finance, American Finance Association, vol. 76(2), pages 537-586, April.
    11. Feixue Gong & Gregory Phelan, 2020. "Debt collateralization, capital structure, and maximal leverage," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 70(2), pages 579-605, September.
    12. Wang, Xinjie & Wu, Yangru & Yan, Hongjun & Zhong, Zhaodong (Ken), 2021. "Funding liquidity shocks in a quasi-experiment: Evidence from the CDS Big Bang," Journal of Financial Economics, Elsevier, vol. 139(2), pages 545-560.
    13. Pascal François & Weiyu Jiang, 2019. "Credit Value Adjustment with Market-implied Recovery," Journal of Financial Services Research, Springer;Western Finance Association, vol. 56(2), pages 145-166, October.
    14. Feixue Gong & Gregory Phelan, 2016. "Debt Collateralization, Structured Finance, and the CDS Basis," Department of Economics Working Papers 2016-06, Department of Economics, Williams College, revised Aug 2017.
    15. Gao, George P. & Lu, Xiaomeng & Song, Zhaogang & Yan, Hongjun, 2019. "Disagreement beta," Journal of Monetary Economics, Elsevier, vol. 107(C), pages 96-113.
    16. Gong Feixue & Gregory Phelan, 2017. "Debt Collateralization, Structured Finance, and the CDS Basis," Department of Economics Working Papers 2017-06, Department of Economics, Williams College.
    17. Binbin Deng, 2017. "Counterparty risk, central counterparty clearing and aggregate risk," Annals of Finance, Springer, vol. 13(4), pages 355-400, November.

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