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Liquidating illiquid collateral

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  • Oehmke, Martin

Abstract

Defaults of financial institutions can cause large, disorderly liquidations of repo collateral. This paper analyzes the dynamics of such liquidations. The model shows that (i) the equilibrium price of the collateral asset can overshoot; (ii) the creditor structure in repo lending involves a fundamental trade-off between risk sharing and inefficient “rushing for the exits” by competing sellers of collateral; (iii) repo lenders should take into account creditor structure, strategic interaction, and their own balance sheet constraints when setting margins; and (iv) the model provides a framework to analyze transfers of repo collateral to “deep-pocket” buyers or a repo resolution authority.

Suggested Citation

  • Oehmke, Martin, 2014. "Liquidating illiquid collateral," Journal of Economic Theory, Elsevier, vol. 149(C), pages 183-210.
  • Handle: RePEc:eee:jetheo:v:149:y:2014:i:c:p:183-210
    DOI: 10.1016/j.jet.2013.02.001
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    Cited by:

    1. Tran, Ngoc-Khanh & Vuong, Thao & Zeckhauser, Richard, 2016. "Loss Sequencing in Banking Networks: Threatened Banks as Strategic Dominoes," Working Paper Series 16-030, Harvard University, John F. Kennedy School of Government.
    2. Clemens Jobst & Kilian Rieder, 2016. "Principles, circumstances and constraints: the Nationalbank as lender of last resort from 1816 to 1931," Monetary Policy & the Economy, Oesterreichische Nationalbank (Austrian Central Bank), issue 3, pages 140-162.
    3. Allen, Franklin & Vayanos, Dimitri & Vives, Xavier, 2014. "Introduction to financial economics," Journal of Economic Theory, Elsevier, vol. 149(C), pages 1-14.
    4. Golec, Pascal & Perotti, Enrico, 2017. "Safe assets: a review," Working Paper Series 2035, European Central Bank.

    More about this item

    Keywords

    Collateral; Liquidation; Repo market; Illiquidity; Fire sales; Creditor structure; Counterparty risk management;

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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