DP8000 Two Monetary Tools: Interest Rates and Haircuts

Author(s): Adam Ashcraft, Nicolae Bogdan Garleanu, Lasse Heje Pedersen
Publication Date: September 2010
Keyword(s): asset pricing, financial frictions, haircuts, liquidity, macroeconomics, margin requirements, monetary policy
JEL(s): E32, E44, E5, G01, G12
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8000

We study a production economy with multiple sectors financed by issuing securities to agents who face capital constraints. Binding capital constraints propagate business cycles, and a reduction of the interest rate can increase the required return of high-haircut assets since it can increase the shadow cost of capital for constrained agents. The required return can be lowered by easing funding constraints through lowering haircuts. To assess empirically the power of the haircut tool, we study the introduction of the legacy Term Asset-Backed Securities Loan Facility (TALF). By considering unpredictable rejections of bonds from TALF, we estimate that haircuts had a significant effect on prices. Further, unique survey evidence suggests that lowering haircuts could reduce required returns by more than 3% and provides broader evidence on the demand sensitivity to haircuts.