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Haircut, Interest Rate, and Collateral Quality in the Tri-Party Repo Market: Evidence and Theory

Author

Listed:
  • Sangyup Choi

    (Yonsei University)

  • Inkee Jang

    (The Catholic University of Korea)

  • Kee-Youn Kang

    (University of Liverpool)

  • Hyunpyung Kim

    (Yonsei University)

Abstract
Leveraging the universe of transaction-level data from the Korean tri-party repo market, we examine how repo contract terms interact with collateral quality.We find that both the haircut and the interest rate increase with collateral risk, consistent with previous findings. However, conditioning on the same collateral quality, we uncover the trade-off between the haircut and the interest rate: A 1% point increase in the interest rate is associated with a 1.3% point reduction in the haircut. Moreover, the rate at which the interest rate substitutes the haircut decreases in market uncertainty, suggesting that the relative importance of insurance instruments increases with default risk. We theoretically show that the interaction between lenders’ incentives to acquire information about collateral quality and borrowers’ incentives to default opportunistically in a collateralized debt market is key to rationalizing the positive (negative) unconditional (conditional) relationship between the haircut and the interest rate.

Suggested Citation

  • Sangyup Choi & Inkee Jang & Kee-Youn Kang & Hyunpyung Kim, 2024. "Haircut, Interest Rate, and Collateral Quality in the Tri-Party Repo Market: Evidence and Theory," Working papers 2024rwp-229, Yonsei University, Yonsei Economics Research Institute.
  • Handle: RePEc:yon:wpaper:2024rwp-229
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    References listed on IDEAS

    as
    1. Ana Fostel & John Geanakoplos, 2012. "Leverage and Default in Binomial Economies: A Complete Characterization," Cowles Foundation Discussion Papers 1877RRR, Cowles Foundation for Research in Economics, Yale University, revised Mar 2015.
    2. Madison, Florian, 2024. "Asymmetric information in frictional markets for liquidity: Collateralized credit vs asset sale," Journal of Economic Dynamics and Control, Elsevier, vol. 159(C).
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    6. Viktoria Baklanova & Cecilia Caglio & Marco Cipriani & Adam Copeland, 2019. "The Use of Collateral in Bilateral Repurchase and Securities Lending Agreements," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 228-249, July.
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    More about this item

    Keywords

    Repo market; collateralized debt; haircut; collateral quality; costly information acquisition; uncertainty.;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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