A standard repurchase agreement between two counterparties is considered to examine the endogenous choice of collateral, the feasibility of secured lending, and welfare implications of the central bank’s collateral framework. As an innovation, we allow for two-sided counterparty risk. In line with empirical observations, it is shown that the most liquid and least risky assets are used as collateral in market transactions first. An endogenous opportunity cost arises from using liquid collateral with the central bank. Conditions are identified such that expected utility increases for all market participants when the central bank accepts a broader range

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A standard repurchase agreement between two counterparties is considered to examine the endogenous choice of collateral, the feasibility of secured lending, and welfare implications of the central bank’s collateral framework. As an innovation, we allow for two-sided counterparty risk. In line with empirical observations, it is shown that the most liquid and least risky assets are used as collateral in market transactions first. An endogenous opportunity cost arises from using liquid collateral with the central bank. Conditions are identified such that expected utility increases for all market participants when the central bank accepts a broader range

Author Info

Christian Ewerhart (University of Zurich - Institute for Empirical Research in Economics (IEW))
Jens Tapking (European Central Bank (ECB))

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Jens Tapking

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Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-24.

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Length: 47 pages
Date of creation: Oct 2007
Date of revision: Sep 2008
Handle: RePEc:chf:rpseri:rp0824

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Find related papers by JEL classification:
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers

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