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

Author

Listed:
  • 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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    1. Dimitri Vayanos & Pierre-Olivier Weill, 2008. "A Search-Based Theory of the On-the-Run Phenomenon," Journal of Finance, American Finance Association, vol. 63(3), pages 1361-1398, June.
    2. Alessandro Gavazza, 2011. "Leasing and Secondary Markets: Theory and Evidence from Commercial Aircraft," Journal of Political Economy, University of Chicago Press, vol. 119(2), pages 325-377.
    3. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
    4. Ferraris, Leo & Watanabe, Makoto, 2008. "Collateral secured loans in a monetary economy," Journal of Economic Theory, Elsevier, vol. 143(1), pages 405-424, November.
    5. Thorsten Koeppl & Cyril Monnet, 2010. "The emergence and future of central counterparties," Working Papers 10-30, Federal Reserve Bank of Philadelphia.
    6. David Mills & Francesca Carapella, 2012. "Information insensitive securities: the benefits of central counterparties," 2012 Meeting Papers 1032, Society for Economic Dynamics.
    7. Timothy J. Kehoe & David K. Levine, 2008. "Bankruptcy and Collateral in Debt Constrained Markets," Chapters,in: Macroeconomics in the Small and the Large, chapter 5 Edward Elgar Publishing.
    8. Koeppl, Thorsten & Monnet, Cyril & Temzelides, Ted, 2012. "Optimal clearing arrangements for financial trades," Journal of Financial Economics, Elsevier, vol. 103(1), pages 189-203.
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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. repec:eee:finsta:v:33:y:2017:i:c:p:311-330 is not listed on IDEAS
    3. Vincent Maurin & Cyril Monnet & Piero Gottardi, 2016. "A Theory of Repurchase Agreement, Collateral Re-use, and Repo Intermediation," 2016 Meeting Papers 417, Society for Economic Dynamics.

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