Collateral Unchained : Rehypothecation networkd, concentration and systemic effects
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.
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