Collateral Unchained: Rehypothecation Networks, Concentration and Systemic Effects

SCIENCES PO OFCE WORKING PAPER n° 07, 2018/01/31

39 Pages Posted: 23 Feb 2018

See all articles by Duc Thi Luu

Duc Thi Luu

University of Kiel- Faculty of Economics and Social Sciences

Mauro Napoletano

Université de Nice Sophia Antipolis - Groupe de Recherche en Droit, Economie et Gestion (GREDEG); Observatoire Français des Conjonctures Economiques (OFCE); SKEMA Business School; Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM)

Paolo Barucca

University of Zurich - Department of Banking and Finance; London Institute for Mathematical Sciences (LIMS); IMT Institute for Advanced Studies

Stefano Battiston

University of Zurich - Department of Banking and Finance; Ca Foscari University of Venice

Date Written: January 31, 2018

Abstract

We study how network structure affects the dynamics of collateral in presence of rehypothecation. We build a simple model wherein banks interact via chains of repo contracts and use their proprietary collateral or re-use the collateral obtained by other banks via reverse repos. In this framework, we show that total collateral volume and its velocity are affected by characteristics of the network like the length of rehypothecation chains, the presence or not of chains having a cyclic structure, the direction of collateral flows, the density of the network. In addition, we show that structures where collateral flows are concentrated among few nodes (like in core-periphery networks) allow large increases in collateral volumes already with small network density. Furthermore, we introduce in the model collateral hoarding rates determined according to a Value-at-Risk (VaR) criterion, and we then study the emergence of collateral hoarding cascades in different networks. Our results highlight that network structures with highly concentrated collateral flows are also more exposed to large collateral hoarding cascades following local shocks. These networks are therefore characterized by a trade-off between liquidity and systemic risk.

Keywords: Rehypothecation, Collateral, Repo Contracts, Networks, Liquidity, Collateral- Hoarding Effects, Systemic Risk.

JEL Classification: G01, G11, G32, G33

Suggested Citation

Luu, Duc Thi and Napoletano, Mauro and Barucca, Paolo and Battiston, Stefano, Collateral Unchained: Rehypothecation Networks, Concentration and Systemic Effects (January 31, 2018). SCIENCES PO OFCE WORKING PAPER n° 07, 2018/01/31 , Available at SSRN: https://ssrn.com/abstract=3123226 or http://dx.doi.org/10.2139/ssrn.3123226

Duc Thi Luu

University of Kiel- Faculty of Economics and Social Sciences ( email )

Olshausenstr. 40
D-24118 Kiel, Schleswig-Holstein 24118
Germany

Mauro Napoletano (Contact Author)

Université de Nice Sophia Antipolis - Groupe de Recherche en Droit, Economie et Gestion (GREDEG) ( email )

250, rue Albert Einstein
Valbonne, 06560
France

Observatoire Français des Conjonctures Economiques (OFCE) ( email )

60, rue Dostoïevski
Sophia-Antipolis Cedex, 06902
France

HOME PAGE: http://www.ofce.sciences-po.fr

SKEMA Business School ( email )

60 rue Dostoïevski
Sophia Antipolis, 06902
France

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM) ( email )

Piazza Martiri della Liberta, 33
Pisa, I-56127
Italy

Paolo Barucca

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

London Institute for Mathematical Sciences (LIMS) ( email )

35a South Street
London, Mayfair W1K 2XF
United Kingdom

IMT Institute for Advanced Studies ( email )

Complesso San Micheletto
Lucca, 55100
Italy

Stefano Battiston

University of Zurich - Department of Banking and Finance ( email )

Andreasstrasse 15
Zürich, 8050
Switzerland

Ca Foscari University of Venice ( email )

Cannaregio 873
Venice, 30121
Italy

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