The Role of Collateral in Credit Markets (original) (raw)
Related papers
2003
The author examines the role of collateral in an environment where lenders and borrowers possess identical information and similar beliefs about its future value. Using option-pricing techniques, he shows that a secured loan contract is equivalent to a regular bond and an embedded option to the borrower to default. He finds that the lender will not advance to the borrower a loan that exceeds the market value of the collateral, and that the supply of loans increases with a rise in the market value of the collateral. Increases in the volatility of the value of the collateral, interest rate, and dividend rate of the collateral independently depress the loan supply. The author also derives the cost of a third-party guarantee of a loan and an implied risk premium.
Collateral Requirements and Asset Prices
SSRN Electronic Journal, 2000
In this paper we examine the effect of collateral requirements on the prices of longlived assets. We consider a Lucas-style infinite-horizon exchange economy with heterogeneous agents and collateral constraints. There are two trees in the economy which can be used as collateral for short-term loans. For the first tree the collateral requirement is determined endogenously while the collateral requirement for loans on the second tree is exogenously regulated. We show that the presence of collateral constraints and the endogenous margin requirements for the first tree lead to large excess price-volatility of the second tree. Changes in the regulated margin requirements for the second tree have large effects on the volatility of both trees. While tightening margins for loans on the second tree always decreases the price volatility of the first tree, price volatility of the second tree might very well increase with this change. In our calibration we allow for the possibility of disaster states. This leads to very large quantitative effects of collateral requirements and to realistic equity risk premia. We show that our qualitative results are robust to the actual parametrization of the economy.
Journal of Economic Surveys, 2000
This paper surveys existing explanations for the pervasive use of collateral in credit markets and relates them to the empirical evidence on the subject. Collateral may be used as a screening or an incentive device in markets characterized by various forms of asymmetric and biased information. The evidence is incompatible with the use of collateral as a signal of projects' quality, while broadly consistent with explanations based on its incentive properties and asymmetric evaluation of projects.
2015), “Collateral requirements and asset prices
2016
In this paper we examine the effect of collateral requirements on the prices of long-lived assets. We consider a Lucas-style infinite-horizon exchange economy with heteroge-nous agents and collateral constraints. There are two trees in the economy which can be used as collateral for short-term loans. For the first tree the collateral requirement is determined endogenously while the collateral requirement for loans on the second tree are exogenously regulated. We show that the presence of collateral constraints and the endogenous margin requirements for the first tree lead to large excess price-volatility of the second tree. Changes in the regulated margin requirements for the second tree have large effects on the volatility of both trees. While tightening margins for loans on the second tree always decreases the price volatility of the first tree, price volatility of the second tree might very well increase with this change. In our calibration we allow for the possibility of disaste...
Collateral, Financial Intermediation, and the Distribution of Debt Capacity
RePEc: Research Papers in Economics, 2008
We study whether borrowers optimally conserve debt capacity to take advantage of investment opportunities due to temporarily low asset prices, when financing is subject to collateral constraints due to limited enforcement. We find that borrowers may exhaust their debt capacity and thus may be unable to take advantage of such opportunities, even if they can arrange for loan commitments or contingent financing. The cost of conserving debt capacity is the opportunity cost of foregone investment. This opportunity cost is higher for borrowers with higher productivity and borrowers who are less well capitalized, and such borrowers are hence more likely to exhaust their debt capacity. Borrowers who exhaust their debt capacity may be forced to contract when cash flows are low, and hence capital may be less productively deployed then. Higher collateralizability may make the contraction more severe. We consider the role of financial intermediaries which are better able to collateralize claims, that is, are "securitization specialists," and study the dynamics of intermediary capital and spreads between intermediated and direct finance. When intermediary capital is scarce and spreads are high, borrowers who exhaust their debt capacity may be forced to contract by even more.
The use of collateral in bilateral repurchase and securities lending agreements
Review of Economic Dynamics, 2019
We use unique data from U.S. bank holding company-affiliated securities dealers to study the use of collateral in bilateral repurchase and securities lending agreements. Market participants' use of collateral differs substantially across asset classes: for U.S. Treasury securities transactions, we find that haircuts are large enough to provide full protection from default, whereas the same is not usually true for equities transactions. Further, although most of the equities in our sample are each associated with a unique haircut, most of the U.S. Treasury securities are each associated with more than one haircut. We relate these findings to implications of the zero value-at-risk feature that can be found in theories of collateral as an enforcement mechanism, and show that the data do not confirm these implications. We then turn to models of adverse selection that predict a negative relationship between haircuts and interest rates, based on the use of collateral as a screening mechanism. We find this negative relationship only for those trades in which the securities dealers are receiving U.S. Treasury securities and delivering cash.
Collateral and Credit Issues in Derivatives Pricing
SSRN Electronic Journal, 2013
Regulatory changes are increasing the importance of collateral agreements and credit issues in over-the-counter derivatives transactions. This paper considers the nature of derivatives collateral agreements and examines the impact of collateral agreements, two-sided credit risk, funding costs, and bid-offer spreads on the valuation of derivatives portfolios.
Loan rates and the two faces of collateral
This paper analyzes the interaction between the loan rate and collateral in curbing default risk in loan contracts. It is shown that collateral may have a favorable or adverse incentive effect on default risk depending on the level of the loan rate. The loan rate and collateral are substitutable from the perspective of competing banks but they may be substitutes or complements from the perspective of borrowing firms. An equilibrium involving firms and banks exists only when the loan rate is low and when the loan rate and collateral are positively affected by firm default risk. The theory provides a general explanation for observations that in practice there are few loans with high rates and that collateral and the loan rate are positively related when the loan rate is below a benchmark level. We test our theory using information from the U.S. Survey of Small Business Finances and show that the empirical results support our theory. . We would like to thank Miquel Faig for helpful comments on an earlier draft of this paper.