Collateralized borrowing and default risk

Eva Lütkebohmert; Yajun Xiao

doi:10.1007/978-3-319-45875-5_8

Collateralized borrowing and default risk

Eva Lütkebohmert^*, Yajun Xiao

^*Corresponding author for this work

Research output: Chapter in Book or Report/Conference proceeding › Conference Proceeding › peer-review

Abstract

We study how margin requirements in the collateralized borrowing affect banks’ risk exposure. In a model where a firm’s asset value and margin requirement follow correlated geometric Brownian motions, we derive analytic expressions for firm’s default probability and debt value. Our results show that variations in margin requirements, reflecting funding liquidity shocks in the short-term collateralized lending market, can lead to a significant increase in firms’ default risks, in particular for those firms heavily relying on short-term collateralized borrowing. Moreover, our results imply that reducing margin in liquidity crises can be very effective to restore market lending confidence.

Original language	English
Title of host publication	Advanced Modelling in Mathematical Finance - In Honour of Ernst Eberlein
Editors	Jan Kallsen, Antonis Papapantoleon
Publisher	Springer New York LLC
Pages	167-187
Number of pages	21
ISBN (Print)	9783319458731
DOIs	https://doi.org/10.1007/978-3-319-45875-5_8
Publication status	Published - 2016
Externally published	Yes
Event	Workshop on Advanced Modelling in Mathematical Finance, 2015 - Kiel, Germany Duration: 20 May 2015 → 22 May 2015

Publication series

Name	Springer Proceedings in Mathematics and Statistics
Volume	189
ISSN (Print)	2194-1009
ISSN (Electronic)	2194-1017

Conference

Conference	Workshop on Advanced Modelling in Mathematical Finance, 2015
Country/Territory	Germany
City	Kiel
Period	20/05/15 → 22/05/15

Keywords

Collateralized borrowing
Funding liquidity
Margin requirements
Structural credit risk models

Access to Document

10.1007/978-3-319-45875-5_8

Cite this

@inproceedings{f31122d03b5c4bb2a0245dc4779938c6,

title = "Collateralized borrowing and default risk",

abstract = "We study how margin requirements in the collateralized borrowing affect banks{\textquoteright} risk exposure. In a model where a firm{\textquoteright}s asset value and margin requirement follow correlated geometric Brownian motions, we derive analytic expressions for firm{\textquoteright}s default probability and debt value. Our results show that variations in margin requirements, reflecting funding liquidity shocks in the short-term collateralized lending market, can lead to a significant increase in firms{\textquoteright} default risks, in particular for those firms heavily relying on short-term collateralized borrowing. Moreover, our results imply that reducing margin in liquidity crises can be very effective to restore market lending confidence.",

keywords = "Collateralized borrowing, Funding liquidity, Margin requirements, Structural credit risk models",

author = "Eva L{\"u}tkebohmert and Yajun Xiao",

note = "Publisher Copyright: {\textcopyright} Springer International Publishing Switzerland 2016.; Workshop on Advanced Modelling in Mathematical Finance, 2015 ; Conference date: 20-05-2015 Through 22-05-2015",

year = "2016",

doi = "10.1007/978-3-319-45875-5_8",

language = "English",

isbn = "9783319458731",

series = "Springer Proceedings in Mathematics and Statistics",

publisher = "Springer New York LLC",

pages = "167--187",

editor = "Jan Kallsen and Antonis Papapantoleon",

booktitle = "Advanced Modelling in Mathematical Finance - In Honour of Ernst Eberlein",

}

Lütkebohmert, E & Xiao, Y 2016, Collateralized borrowing and default risk. in J Kallsen & A Papapantoleon (eds), Advanced Modelling in Mathematical Finance - In Honour of Ernst Eberlein. Springer Proceedings in Mathematics and Statistics, vol. 189, Springer New York LLC, pp. 167-187, Workshop on Advanced Modelling in Mathematical Finance, 2015, Kiel, Germany, 20/05/15. https://doi.org/10.1007/978-3-319-45875-5_8

Collateralized borrowing and default risk. / Lütkebohmert, Eva; Xiao, Yajun.
Advanced Modelling in Mathematical Finance - In Honour of Ernst Eberlein. ed. / Jan Kallsen; Antonis Papapantoleon. Springer New York LLC, 2016. p. 167-187 (Springer Proceedings in Mathematics and Statistics; Vol. 189).

Research output: Chapter in Book or Report/Conference proceeding › Conference Proceeding › peer-review

TY - GEN

T1 - Collateralized borrowing and default risk

AU - Lütkebohmert, Eva

AU - Xiao, Yajun

N1 - Publisher Copyright: © Springer International Publishing Switzerland 2016.

PY - 2016

Y1 - 2016

N2 - We study how margin requirements in the collateralized borrowing affect banks’ risk exposure. In a model where a firm’s asset value and margin requirement follow correlated geometric Brownian motions, we derive analytic expressions for firm’s default probability and debt value. Our results show that variations in margin requirements, reflecting funding liquidity shocks in the short-term collateralized lending market, can lead to a significant increase in firms’ default risks, in particular for those firms heavily relying on short-term collateralized borrowing. Moreover, our results imply that reducing margin in liquidity crises can be very effective to restore market lending confidence.

AB - We study how margin requirements in the collateralized borrowing affect banks’ risk exposure. In a model where a firm’s asset value and margin requirement follow correlated geometric Brownian motions, we derive analytic expressions for firm’s default probability and debt value. Our results show that variations in margin requirements, reflecting funding liquidity shocks in the short-term collateralized lending market, can lead to a significant increase in firms’ default risks, in particular for those firms heavily relying on short-term collateralized borrowing. Moreover, our results imply that reducing margin in liquidity crises can be very effective to restore market lending confidence.

KW - Collateralized borrowing

KW - Funding liquidity

KW - Margin requirements

KW - Structural credit risk models

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DO - 10.1007/978-3-319-45875-5_8

M3 - Conference Proceeding

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T3 - Springer Proceedings in Mathematics and Statistics

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BT - Advanced Modelling in Mathematical Finance - In Honour of Ernst Eberlein

A2 - Kallsen, Jan

A2 - Papapantoleon, Antonis

PB - Springer New York LLC

T2 - Workshop on Advanced Modelling in Mathematical Finance, 2015

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ER -

Collateralized borrowing and default risk

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Keywords

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