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Crashes and Collateralized Lending

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  • Jakub W. Jurek
  • Erik Stafford

Abstract

This paper develops a parsimonious static model for characterizing financing terms in collateralized lending markets. We characterize the systematic risk exposures for a variety of securities and develop a simple indifference-pricing framework to value the systematic crash risk exposure of the collateral. We then apply Modigliani and Miller's (1958) Proposition Two (MM) to split the cost of bearing this risk between the borrower and lender, resulting in a schedule of haircuts and financing rates. The model produces comparative statics and time-series dynamics that are consistent with the empirical features of repo market data, including the dramatic change in financing terms for structured products during the credit crisis of 2007-2008.

Suggested Citation

  • Jakub W. Jurek & Erik Stafford, 2011. "Crashes and Collateralized Lending," NBER Working Papers 17422, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:17422
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G2 - Financial Economics - - Financial Institutions and Services

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