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The fragility of short-term secured funding markets
von Thadden, Ernst-Ludwig; Skeie, David R.; Martin, Antoine (2013)
This paper develops a model of financial institutions that borrow short term and invest in long-term assets that can be traded in frictionless markets. Because these financial intermediaries perform maturity transformation, they are subject to potential runs. We derive distinct liquidity, collateral, and asset liquidation constraints, which determine whether a run can occur as a result of changing market expectations. We show that the extent to which borrowers can ward off an individual run depends on whether it has sufficient liquidity, collateral, and asset liquidation capacity. These ...
Staff Reports , Paper 630

Working Paper
Collateral Reuse and Financial Stability
Chang, Jin-Wook; Chuan, Grace (2025-05-20)
The isolated effects of collateral reuse on financial stability are ambiguous and understudied. While greater collateral reuse can guarantee more payments with fewer assets, it can also increase the exposure to potential drops in collateral price. To analyze these tradeoffs, we develop a financial network model with endogenous asset pricing, multiple equilibria, and equilibrium selection. We find that more collateral reuse decreases the likelihood of the worst equilibrium (crisis), with varying effects depending on the network structure. Therefore, collateral reuse can unambiguously improve ...
Finance and Economics Discussion Series , Paper 2025-035

Report
Is It Too Late to Bail Out the Troubled Countries in the Eurozone?
Conesa, Juan Carlos; Kehoe, Timothy J. (2014-02-05)
In January 1995, U.S. President Bill Clinton organized a bailout for Mexico that imposed penalty interest rates and induced the Mexican government to reduce its debt, ending the debt crisis. Can the Troika (European Commission, European Central Bank, and International Monetary Fund) organize similar bailouts for the troubled countries in the Eurozone? Our analysis suggests that debt levels are so high that bailouts with penalty interest rates could induce the Eurozone governments to default rather than reduce their debt. A resumption of economic growth is one of the few ways that the Eurozone ...
Staff Report , Paper 497

Working Paper
Collateral Runs
Vardoulakis, Alexandros; Infante, Sebastian (2018-04-04)
This paper models an unexplored source of liquidity risk faced by large broker-dealers: collateral runs. By setting different contracting terms on repurchase agreements with cash borrowers and lenders, dealers can source funds for their own activities. Cash borrowers internalize the risk of losing their collateral in case their dealer defaults, prompting them to withdraw it. This incentive creates strategic complementarities for counterparties to withdraw their collateral, reducing a dealer's liquidity position and compromising her solvency. Collateral runs are markedly different than ...
Finance and Economics Discussion Series , Paper 2018-022

Working Paper
Interest Rate Dynamics, Variable-Rate Loan Contracts, and the Business Cycle
Wen, Yi; Pintus, Patrick A.; Xing, Xiaochuan (2015-09-01)
The interest rate at which US firms borrow funds has two features: (i) it moves in a countercyclical fashion and (ii) it is an inverted leading indicator of real economic activity: low interest rates forecast booms in GDP, consumption, investment, and employment. We show that a Kiyotaki-Moore model accounts for both properties when business-cycle movements are driven, in a significant way, by animal spirit shocks to credit-financed investment demand. The credit-based nature of such self-fulfilling equilibria is shown to be essential: the dynamic correlation between current loanable funds rate ...
Working Papers , Paper 2015-32

Working Paper
Asset Pledgeability and Endogenously Leveraged Bubbles
Phan, Toan; Bengui, Julien (2018-04-19)
We develop a simple model of defaultable debt and rational bubbles in the price of an asset, which can be pledged as collateral in a competitive credit pool. When the asset pledgeability is low, the down payment is high, and bubble investment is unleveraged, as in a standard rational bubble model. When the pledgeability is high, the down payment is low, making it easier for leveraged borrowers to invest in the bubbly asset. As loans are packaged together into a competitive pool, the pricing of individual default risk may facilitate risk-taking. In equilibrium, credit-constrained borrowers may ...
Working Paper , Paper 18-11

Working Paper
What Drives U.S. Treasury Re-use?
Infante, Sebastian; Saravay, Zack (2021-08-24)
We study what drives the re-use of U.S. Treasury securities in the financial system. Using confidential supervisory data, we estimate the degree of collateral re-use at the dealer level through their collateral multiplier : the ratio between a dealer's total secured funding and their outright holdings financed through secured funding. We find that Treasury re-use increases as the supply of available securities decreases, especially when supply declines due to Federal Reserve asset purchases. We also find that non-U.S. dealers' re-use increases when profits from intermediating cash are high, ...
Finance and Economics Discussion Series , Paper 2020-103r1

Working Paper
Debt Deflation Effects of Monetary Policy
Vardoulakis, Alexandros; Tsomocos, Dimitrios P.; Lin, Li (2014-05-07)
This paper assesses the role that monetary policy plays in the decision to default using a General Equilibrium model with collateralized loans, trade in fiat money and production. Long-term nominal loans are backed by collateral, the value of which depends on monetary policy. The decision to default is endogenous and depends on the relative value of the collateral to face value of the loan. Default results in foreclosure, higher borrowing costs, inefficient investment and a decrease in total output. We show that pre-crisis contractionary monetary policy interacts with Fisherian debt-deflation ...
Finance and Economics Discussion Series , Paper 2014-37

Working Paper
A Model of Endogenous Debt Maturity with Heterogeneous Beliefs
Darst, Matt; Refayet, Ehraz (2017-05)
This paper studies optimal debt maturity in an economy with repayment enforcement frictions and investors disagree about repayment probabilities. The optimal debt maturity choice is a mix of long- and short-term debt securities. Spreading risky debt claims on cash flows over time allows debt to be priced by investors most willing to hold risk at each point in time, thereby increasing investment and output. By contrast, a single maturity, either all long- or short-term, will be priced by investors less willing to hold risk, which reduces investment and output. The model provides a novel ...
Finance and Economics Discussion Series , Paper 2017-057

Report
A Dynamic Theory of Collateral Quality and Long-Term Interventions
Neuhann, Daniel; Lee, Michael Junho (2019-08-07)
We study a dynamic model of collateralized lending under adverse selection in which the quality of collateral assets is endogenously determined by hidden effort. Complementarities in incentives lead to non-ergodic dynamics: Asset quality and output grow when asset quality is high, but stagnate or deteriorate otherwise. Inefficiencies remain, even in the most efficient competitive equilibrium?investment and output are vulnerable to spells of lending market illiquidity, and these spells may persist because of suboptimal effort. Nevertheless, benevolent regulators without commitment can destroy ...
Staff Reports , Paper 894

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