Discussion Paper Series 2016-E-8

Choice of Collateral Asset and the Cross-Border Effect of Automatic Stays

Hiroshi Fujiki, Charles M. Kahn

We analyze the choice of collateral for use in repurchase agreement (repo) contracts based on an optimal contract model, and examine when regulatory restrictions are appropriate on the use of types of collateral in repo contracts, especially on the exemption to the automatic stay requirements. Our analyses imply that the crucial characteristics of the assets more desirable as collateral in an optimal contract are lower opportunity cost to create the collateral, lower hazard rate in the distribution of valuations of the collateral assets, and higher negative correlation of valuations between borrower and lender. We consider an externality based on divergence between market price and buyer's surplus in a resale asset market, and analyze its effect on the welfare consequences of the exemption to the automatic stay requirements. We also consider the welfare consequences when national regulators evaluate the welfare benefits only from their national perspectives.

Keywords: repo market; the exemption from automatic stays; collateral; cross-border financial transaction

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

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