Repo markets, counterparty risk and the 2007/2008 liquidity crisis

Abstract

A standard repurchase agreement between two counterparties is considered to examine the endogenous choice of collateral assets, the feasibility of secured lending, and welfare implications of the central bank’s collateral framework. As an important innovation, we allow for two-sided counterparty risk. Our findings relate to empirical characteristics of repo transactions and have an immediate bearing on market developments since August 2007. JEL Classification: G21, G32, E51collateral, Counterparty risk, haircuts, liquidity, repurchase agreements