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Re-use of collateral: Leverage, volatility, and welfare

Author

Listed:
  • Johannes Brumm

    (Karlsruhe Institute of Technology)

  • Michael Grill

    (European Central Bank)

  • Felix Kubler

    (University of Zurich)

  • Karl Schmedders

    (IMD Lausanne)

Abstract

We assess the implications of collateral re-use on leverage, volatility, and welfare within a calibrated infinite-horizon asset-pricing model with heterogeneous agents and disaster shocks. In our model, the ability of agents to reuse frees up collateral that can be used to back more transactions. Re-use thus contributes to the buildup of leverage and significantly increases volatility in financial markets. When introducing limits on re-use, we find that volatility is strictly decreasing as these limits become tighter, yet the impact on welfare is non-monotone. In the model, allowing for some re-use can improve welfare as it enables agents to share risk more effectively. Allowing re-use beyond intermediate levels, however, can lead to excessive leverage and lower welfare. So the analysis in this paper provides a rationale for limiting, yet not banning, re-use in financial markets. (Copyright: Elsevier)

Suggested Citation

  • Johannes Brumm & Michael Grill & Felix Kubler & Karl Schmedders, 2023. "Re-use of collateral: Leverage, volatility, and welfare," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 47, pages 19-46, January.
  • Handle: RePEc:red:issued:20-480
    DOI: 10.1016/j.red.2022.03.003
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    More about this item

    Keywords

    Collateral re-use; Disaster shocks; Heterogeneous agents; Leverage; Volatility; Welfare;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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