Investment Horizon and Repo in the Over-the-Counter Market

Abstract

This paper presents a three-period model featuring a short-term investor in the over-the-counter bond market. A short-term investor stores cash because of a need to pay cash at some future date. If a short-term investor buys bonds, then a deadline for retrieving cash lowers the resale price of bonds for the investor through bilateral bargaining in the bond market. Ex-ante, this holdup problem explains the use of a repo by a short-term investor, the existence of a haircut, and the vulnerability of a repo market to counterparty risk. This result holds without any uncertainty about bond returns or asymmetric information.JEL codes: G24 Keywords: repo, over-the-counter market, securities broker-dealer; short-term investor; haircut.A REPO IS ONE OF THE PRIMARY instruments in the money market. In this transaction, a short-term investor buys long-term bonds with a repurchase agreement in which the seller of the bonds promises to buy back the bonds at a later date. From the seller's point of view, this transaction is akin to a secured loan with the underlying bonds as collateral. A question remains, however, regarding why a short-term investor needs a repurchase agreement when the investor can simply resell bonds to a third party in a spot market. The answer to this question is not immediately I thank

Asymmetric information in frictional markets for liquidity: Collateralized credit vs asset sale

“…In her model, assets entail a liquidity and a collateral premium, where an increase in liquidity increases the liquidity premium of assets, while the collateral premium declines, suggesting non-equivalence. Tomura (2016) explains the demand for collateralized credit with a holdup problem introduced through a deadline on retrieving cash. An urgent need to liquidate bonds on an over-the-counter market weakens the bargaining power of the selling party and disincentivizes the acquisition of that bond in the rst place.…”

Optimal Interventions on Strategic Fails in Repo Markets

“…Each seller holds one unit of a security, which pays out value v > 0 at the end of period 2. For simplicity, we assume that agents can hold at most one unit of the security, following Duffie, Gârleanu, and Pedersen [6]; Vayanos and Weill [26]; Tomura [23]; and Infante [15] among others. "One unit" can be interpreted as the unit that a buyer wants to trade and that a counterparty seller agrees to trade.…”

“…Vayanos and Weill [26] explain why just-issued bonds ("on-the-run") trade at lower yields than previously issued bonds, when short positions can be established in a repo market. Tomura [23] shows that a need for a repo arises from an investor's short investment horizon. Our model shares basic structures with their models, such as search and bargaining frictions.…”

A Theory of Repurchase Agreements, Collateral Re-Use, and Repo Intermediation

“…Duffie, 1996) or search frictions (e.g. Narajabad and Monnet, 2012, Tomura, 2016, and Parlatore, 2018. Bundling the sale and the repurchase of the asset in one transaction lowers search costs or mitigates bargaining inefficiencies.…”