Liquidating illiquid collateral

Oehmke, Martin

doi:10.1016/j.jet.2013.02.001

Cited by 36 publications

(5 citation statements)

References 40 publications

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“…Brunnermeier and Pedersen (2009) introduce margin constraints that follow a Value-at-Risk rule, and stress the interaction of market and funding liquidity. Oehmke (2008 and studies the speed and the spreading of price deviations when arbitrageurs face Value-at-Risk or other risk management constraints.…”

Section: Discussionmentioning

confidence: 99%

Procyclical Leverage and Value-at-Risk

2013

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The availability of credit varies over the business cycle through shifts in the leverage of financial intermediaries. Empirically, we find that intermediary leverage is negatively aligned with the banks' value-at-risk (VaR). Motivated by the evidence, we explore a contracting model that captures the observed features. Under general conditions on the outcome distribution given by Extreme Value Theory (EVT), intermediaries maintain a constant probability of default to shifts in the outcome distribution, implying substantial deleveraging during downturns. For some parameter values, we can solve the model explicitly, thereby endogenizing the VaR threshold probability from the contracting problem.JEL classification: G21, G32

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Section: Discussionmentioning

confidence: 99%

Procyclical Leverage and Value-at-Risk

2013

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“…The original E-N network has been generalized in several aspects. These aspects include equity cross-holdings by Elsinger (2011), default costs by Rogers and Veraart (2012), inefficient collateral liquidation upon defaults by Oehmke (2014), fire sale and capital requirement by Feinstein and El-Masri (2015), endogenous formation of linkages by Farboodi (2015) and Wang (2015). Our paper complements this growing literature by modeling banks' self-centered responses to their direct losses, a realistic feature that is key to understanding our quest: the importance of the loss sequencing in financial networks.…”

Section: Related Literaturementioning

confidence: 91%

Loss Sequencing in Banking Networks: Threatened Banks As Strategic Dominoes

2018

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We demonstrate in a stylized banking network that a single large loss has the potential to leave markedly different impacts on the financial system than does a sequence of moderate losses of the same cumulative magnitude. Loss sequencing matters because banks make strategic bailout decisions based on their myopic assessment of losses, yet these decisions are highly consequential to subsequent decisions and eventual losses at other banks in the network. In particular, the network mechanism enables banks to choose to bail out their creditors after every moderate loss incurred in a sequence, while walking away from the creditors should they experience a single large loss. Government policy can force threatened banks to liquidate or sell themselves or, at the opposite pole, can bail out some such banks or overlook their threatened status. The former policy would concentrate a string of losses into a single large event; the latter could prevent a massive single loss at the expense of multiple subsequent smaller losses. As this analysis shows, either policy could prove optimal depending on identifiable circumstances. These findings have important implications for ongoing policy debates that emanated from the 2008 meltdown.

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“…(), Acharya, Anshuman, and Viswanathan (), and Auh and Sundaresan () also offer an ex ante and ex post analysis of exemptions from the automatic stay, but with a specific focus on repo contracts. Oehmke () provides a model of collateral fire sales that can occur after defaults in the repo markets. Infante () explores the ex ante implications of collateral fire sales.…”

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confidence: 99%

Should Derivatives Be Privileged in Bankruptcy?

Bolton¹,

Oehmke

2015

The Journal of Finance

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Derivatives enjoy special status in bankruptcy: They are exempt from the automatic stay and effectively senior to virtually all other claims. We propose a corporate finance model to assess the effect of these exemptions on a firm's cost of borrowing and its incentives to engage in efficient derivative transactions. While derivatives are value-enhancing risk management tools, seniority for derivatives can lead to inefficiencies: It transfers credit risk to debtholders, even though this risk is borne more efficiently in the derivative market. Seniority for derivatives is efficient only if it provides sufficient cross-netting benefits to derivative counterparties that provide hedging services. * Bolton is at Columbia University, NBER, and CEPR. Oehmke is at Columbia University. For helpful comments and suggestions, we thank two anonymous referees, an associate editor, Viral Acharya, Jun Kyung Auh, Ulf Axelson, Ken Ayotte, Mike Burkart, Doug Diamond, Darrell Duffie, Yaniv Grinstein, Oliver Hart, Gustavo Manso, Ed Morrison, David Scharfstein, Ken Singleton (editor), Jeremy Stein, Suresh Sundaresan, Vikrant Vig, Jeff Zwiebel, and seminar participants at Columbia University, the UBC Winter Finance Conference, Temple University, University of Rochester, the Moody's/LBS Credit Risk Conference, LSE, LBS, Stockholm School of Economics, Mannheim, HEC, INSEAD, CEU, the 2011 ALEA meetings, the 4th annual Paul Woolley Conference, the 2011 NBER Summer Institute, ESSFM Gerzensee, the 2011 SITE Conference, ESMT Berlin, Harvard Law School, Harvard Business School, Chicago Booth, University of Amsterdam, EPF Lausanne, Stanford GSB, Berkeley, the NY Fed workshop on the automatic stay, the 2012 WFA meetings, Wharton, and Boston University.Derivative contracts enjoy special status under U.S. bankruptcy law: Derivative counterparties are exempt from the automatic stay, and-through netting, closeout, and collateralization provisionsthey are generally able to immediately collect payment from a defaulted counterparty. 1 Taken together, these special provisions make derivative counterparties effectively senior to almost all other claimants in bankruptcy. The costs and benefits of this special treatment are the subject of a recent debate among legal scholars, policymakers, and regulators. Notably, this debate is characterized by considerable disagreement about the costs and benefits of the special bankruptcy treatment of derivatives, which is reflected in substantial differences in the bankruptcy treatment of derivatives across different jurisdictions. 2 In this paper we provide the first formal analysis of the economic consequences of the privileged treatment of derivative contracts in bankruptcy. The fundamental observation underlying our analysis is that (effective) seniority for derivatives does not eliminate default risk-it transfers default risk from derivative counterparties to other claimholders, particularly creditors. The desirability of seniority for derivatives thus depends on whether default risk is more efficiently bor...

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Liquidating illiquid collateral

Cited by 36 publications

References 40 publications

Procyclical Leverage and Value-at-Risk

Procyclical Leverage and Value-at-Risk

Loss Sequencing in Banking Networks: Threatened Banks As Strategic Dominoes

Should Derivatives Be Privileged in Bankruptcy?

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