Repo Runs

Abstract

This paper develops a model of financial institutions that borrow shortterm and invest into long-term marketable assets. Because these financial intermediaries perform maturity transformation, they are subject to runs. We endogenize the profits of the intermediary and derive distinct liquidity and solvency conditions that determine whether a run can be prevented. We first characterize these conditions for an isolated intermediary and then generalize them to the case where the intermediary can sell assets to prevent runs. The sale of assets can eliminate runs if the intermediary is solvent but illiquid. However, because of cash-in-the-market pricing, this becomes less likely the more intermediaries are facing problems. In the limit, in case of a general market run, no intermediary can sell assets to forestall a run, and our original solvency and liquidity constraints are again relevant for the stability of financial institutions.