The fragility of short-term secured funding markets

Abstract: This paper develops a model of financial institutions that borrow short term and invest in long-term assets that can be traded in frictionless markets. Because these financial intermediaries perform maturity transformation, they are subject to potential runs. We derive distinct liquidity, collateral, and asset liquidation constraints, which determine whether a run can occur as a result of changing market expectations. We show that the extent to which borrowers can ward off an individual run depends on whether it has sufficient liquidity, collateral, and asset liquidation capacity. These determinants are endogenous and depend on the borrower's balance sheet, in terms of asset market exposure and leverage, and on fundamentals, such as productivity and size. Moreover, systemic runs are possible if shocks to the valuation of collateral held by outside investors are sufficiently strong and uniform, and if the system as a whole is exposed to high short-term funding risk.

Keywords: systemic risk; investment banking; securities dealers; runs; repurchase agreements; financial fragility; collateral;

JEL Classification: E44; E58; G24;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2013

Number: 630

Note: For a published version of this report, see Antoine Martin, David Skeie, and Ernst-Ludwig von Thadden, "The Fragility of Short-Term Secured Funding Markets," Journal of Economic Theory 149 (January 2014): 15-42.