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Why Rent When You Can Buy? A Theory of Repurchase Agreements

Author

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  • Borghan Nezami Narajabad

    (Rice University)

  • Cyril Monnet

    (Universitat Bern)

Abstract

In a model with matching frictions, we provide conditions under which repurchase agreements (or repos) co-exist with asset sales. In a repo, the seller agrees to repurchase the asset at a later date at the agreed price. Absent bilateral trading frictions, repos have no role despite uncertainty about future valuations. Introducing pairwise meetings, we show that agents prefer to sell (or buy) assets whenever they face little uncertainty regarding the future use of the asset. As agents become more uncertain of the value of holding the asset, repos become more prevalent. We show that while the total volume of repos is always increasing with the uncertainty, the total sales volume is hump-shaped. In other words, pairwise matching alone is sufficient to explain why repo markets exist and there is no need to introduce random matching, search frictions, information asymmetries or other market frictions.

Suggested Citation

  • Borghan Nezami Narajabad & Cyril Monnet, 2012. "Why Rent When You Can Buy? A Theory of Repurchase Agreements," 2012 Meeting Papers 647, Society for Economic Dynamics.
  • Handle: RePEc:red:sed012:647
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    References listed on IDEAS

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    Cited by:

    1. Andolfatto, David & Martin, Fernando M. & Zhang, Shengxing, 2017. "Rehypothecation and liquidity," European Economic Review, Elsevier, vol. 100(C), pages 488-505.
    2. Piero Gottardi & Vincent Maurin & Cyril Monnet, 2019. "A theory of repurchase agreements, collateral re-use, and repo intermediation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 30-56, July.
    3. Trejos, Alberto & Wright, Randall, 2016. "Search-based models of money and finance: An integrated approach," Journal of Economic Theory, Elsevier, vol. 164(C), pages 10-31.
    4. Kang, Kee-Youn, 2021. "Optimal contract for asset trades: Collateralizing or selling?," Journal of Financial Markets, Elsevier, vol. 56(C).
    5. Buschmann, Christian & Schmaltz, Christian, 2017. "Sovereign collateral as a Trojan Horse: Why do we need an LCR+," Journal of Financial Stability, Elsevier, vol. 33(C), pages 311-330.
    6. Parlatore, Cecilia, 2019. "Collateralizing liquidity," Journal of Financial Economics, Elsevier, vol. 131(2), pages 299-322.

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