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'Collateralizing Liquidity'

Detail Summary
Date 21 June 2016
Time 13:00 - 14:30

Abstract:

I develop a dynamic model of optimal funding to understand why liquid financial assets are used as collateral. Firms need to borrow to invest in risky projects with non-verifiable returns. Since holding assets allows firms to invest in profitable projects, firms with investment opportunities value the asset more than those without them. When investment opportunities are persistent, current borrowers also expect to value the asset more in the future and liquid financial assets are optimally used as collateral. Assets carry liquidity and collateral premia. As liquidity increases, the liquidity premium increases while the collateral premium decreases.