Collateralized borrowing and default risk

Eva Lütkebohmert*, Yajun Xiao

*Corresponding author for this work

Research output: Chapter in Book or Report/Conference proceedingConference Proceedingpeer-review


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 languageEnglish
Title of host publicationAdvanced Modelling in Mathematical Finance - In Honour of Ernst Eberlein
EditorsJan Kallsen, Antonis Papapantoleon
PublisherSpringer New York LLC
Number of pages21
ISBN (Print)9783319458731
Publication statusPublished - 2016
Externally publishedYes
EventWorkshop on Advanced Modelling in Mathematical Finance, 2015 - Kiel, Germany
Duration: 20 May 201522 May 2015

Publication series

NameSpringer Proceedings in Mathematics and Statistics
ISSN (Print)2194-1009
ISSN (Electronic)2194-1017


ConferenceWorkshop on Advanced Modelling in Mathematical Finance, 2015


  • Collateralized borrowing
  • Funding liquidity
  • Margin requirements
  • Structural credit risk models


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