Home About Latest Browse RSS Advanced Search

Federal Reserve Bank of Chicago
Working Paper Series
Interest Rates or Haircuts? Prices Versus Quantities in the Market for Collateralized Risky Loans
Robert Barsky
Theodore Bogusz
Matthew Easton
Abstract

Markets for risky loans clear on two dimensions - an interest rate (or equivalently a spread above the riskless rate) and a specification of the amount of collateral per dollar of lending. The latter is summarized by the margin or "haircut" associated with the loan. Some key models of endogenous collateral constraints imply that the primary equilibrating force will be in the form of haircuts rather than movements in interest rate spreads. Indeed, an important benchmark model, derived in a two-state world, implies that haircuts will adjust to render all lending riskless, and that a loss of risk capital on the part of borrowers has profound effects on asset prices. Quantitative analysis of a model of collateral equilibrium with a continuum of states turns these results on their heads. The bulk of the response to lenders' perception of increased default risk is in the form of higher default premia. Further, with high initial leverage, reductions in risk capital decrease equilibrium margins almost proportionately, while asset prices barely move. To the extent that one believes that it is a stylized fact that haircuts move more than spreads - as seen, for example, in bilateral repo data from 2007-2008 - this reversal is disturbing.


Download Full text
Cite this item
Robert Barsky & Theodore Bogusz & Matthew Easton, Interest Rates or Haircuts? Prices Versus Quantities in the Market for Collateralized Risky Loans, Federal Reserve Bank of Chicago, Working Paper Series WP-2016-19, 29 Nov 2016.
More from this series
JEL Classification:
Subject headings:
Keywords: leverage cycle; margins; financial crises; repo; risk; collateral; belief disagreements
For corrections, contact Bernie Flores ()
Fed-in-Print is the central catalog of publications within the Federal Reserve System. It is managed and hosted by the Economic Research Division, Federal Reserve Bank of St. Louis.

Privacy Legal