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Securitized Bank ing and The Run On Repo

Securitized Bank ing and The Run On Repo. Gary B. Gorton Andrew Metrick. Group Members : Aladeloye Oluwaseyi Afolarin Adisa Champa Gunawardhana Gianfrancesco Rinelli Jinliang Cao Kadri Ulukan Peterson Ozili Xin Zhu. INTRODUCTION.

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Securitized Bank ing and The Run On Repo

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  1. Securitized BankingandThe Run On Repo Gary B. Gorton Andrew Metrick Group Members: AladeloyeOluwaseyi AfolarinAdisa ChampaGunawardhana GianfrancescoRinelli Jinliang CaoKadriUlukan Peterson OziliXin Zhu

  2. INTRODUCTION • GortonandMetwickexaminesthepanic on repo market andrelationbtwinterbank market andcreditspreads. • Securitizedbankingwere at thenexus of thecrisis. • Thecrisis spread fromsubprimehousingassetstonon-subprime, non-housingassets: Contagion

  3. INTRODUCTION

  4. II. INSTITUTIONAL BACKGROUND • SUBPRIME MORTGAGE MARKET • Resetfixed-rate mortgages • Refinancingof mortgages • SECURITIZATION • In 2005-2006, 80% of mortgagesweresold in RMBS • SPVsboughtmortgagesandfinancedbyissuinginvestmentgradesecurities. • Lots of newfin. instrumentsintroduced (CDS, CDOs, CLOs…)

  5. II. INSTITUTIONAL BACKGROUND • C. REPO MARKET • Size of the repo-market growedfastin lastyears. • Investmentbanksfundedalmosthalf of theirassetsvia repo markets.

  6. III. STATE VARIABLES • SUBPRIME FUNDAMENTALS AND ABX INDICES • ABX Indicesreferences 20 equallyweightedsubprime RMBS tranches • Subindiceswithspecificratings (AAA, AA, B, BBB …) • Subprime-relatedassetsaretraded in primary market andunobservable • ABX Index make market observableandhelptopricesubprime risk • TheInterbank Market and LIB-OIS Spread • Proxy forInterbank market is LIBOR – Overnight Index Swap rate. • LIBOR: rate paid on unsecuredinterbankloans • OIS: risk free rate, referenceforfixed-to-floatingint. rate swaps

  7. III. STATE VARIABLES B. TheInterbank Market and LIB-OIS Spread • LIB-OIS spread is an arbitrageopportunity • Spread alsomeanscounterparty risk in thebankingsystem.

  8. EmpiricalApproach • Dataset: • 392 secutitized bonds (ABS, CDOS,CDS..) from dealer banks • Weeklyobservation from january 2007 to january 2009 • Regressions • Crisispropagation • Run on the repo market

  9. CrisisPropagation Regression Framework: Si,tSpread of asset i at time t ABXtvector of the last 4 observation of the ABX spread  securitizedassetsrelated to the subprimesector LIB-OIStvector of the last 4 observation of LIB-OIS spread  interbankmarket’srisk XtControls’ vector

  10. Significantcoefficientsat 5% Significantcoefficientsat10% LIBOR-OIS coefficients are jointlysignificant… ABX onesdon’t

  11. Summary of the F-test 54% of the regressionshavesignificant F-test for the LIBOR-OIS 98% of those show a positive effect of LIB-OIS over the spread of the assetconsidered Theincrease in the non subprimesector’s spread waspositivelycorrelated with the LIBOR-OIS

  12. The run on the repo 2 features: • Increase in the repo rate • Increase in the haircut

  13. Increase in the Repo rate Regression Framework: Lookingforwardmeasure The increase in the repo rate wasstronglycorrelated with the LIBOR-OIS

  14. Increase in the Haircuts Regression Framework: LIB-OIS and ABX coefficients are notjointlysignificant Volatilitymatters

  15. Findings Asset’s Spread LIB-OIS Repo rate Run on the Repo ? Haircut Volatility

  16. Conclusions • Contagionwasdriven by the interbank market • A disruption in the interbank market and increases in uncertainty about collateral are both necessary conditions for a run on repo. Lehman’sBrothersbankrupt Northern Rock Run

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