DP15782 (In)efficient repo markets

Author(s): Tobias Dieler, Loriano Mancini, Norman Schürhoff
Publication Date: February 2021
Keyword(s): asymmetric information, Central clearing, Collateral, Financial Stability, funding run, guarantee fund, novation, repo market
JEL(s): G01, G14, G21, G28
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15782

Repo markets trade off the efficient allocation of liquidity in the financial sector with resilience to funding shocks. The repo trading and clearing mechanisms are crucial determinants of the allocation-resilience tradeoff. The two common mechanisms, anonymous central-counterparty (CCP) and non-anonymous over-the-counter (OTC) markets, are inefficient and their welfare rankings depend on funding tightness. CCP (OTC) markets inefficiently liquidate high (low) quality assets for large (small) funding shocks. Two innovations to repo market design contribute to maximize welfare: a liquidity-contingent trading mechanism and a two-tiered guarantee fund.