Re-use of collateral: Leverage, volatility, and welfare

Johannes Brumm, Michael Grill, Felix Kubler, Karl Schmedders*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

We assess the implications of collateral re-use on leverage, volatility, and welfare within a calibrated infinite-horizon asset-pricing model with heterogeneous agents and disaster shocks. In our model, the ability of agents to reuse frees up collateral that can be used to back more transactions. Re-use thus contributes to the buildup of leverage and significantly increases volatility in financial markets. When introducing limits on re-use, we find that volatility is strictly decreasing as these limits become tighter, yet the impact on welfare is non-monotone. In the model, allowing for some re-use can improve welfare as it enables agents to share risk more effectively. Allowing re-use beyond intermediate levels, however, can lead to excessive leverage and lower welfare. So the analysis in this paper provides a rationale for limiting, yet not banning, re-use in financial markets.

Original languageEnglish (US)
Pages (from-to)19-46
Number of pages28
JournalReview of Economic Dynamics
Volume47
DOIs
StatePublished - Jan 2023

Keywords

  • Collateral re-use
  • Disaster shocks
  • Heterogeneous agents
  • Leverage
  • Volatility
  • Welfare

ASJC Scopus subject areas

  • Economics and Econometrics

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