Mathematical Finance Seminar

Repo Haircut and Pricing

Speaker: Wujiang Lou, HSBC

Location: Warren Weaver Hall 1302

Date: Tuesday, March 5, 2019, 5:30 p.m.

Synopsis:

Repo haircut is a fraction used to reduce collateral security’s market value to provide a cushion against possible market declines. As a non-valuation measure, exactly how it is determined has been a myth. We develop a repo haircut model by treating repos as debt investments and seeks haircuts to control counterparty risk exposure. The model explains tri-party and bilateral repo haircut differences, recasts haircut increases during the financial crisis, and sets a limit on access liquidity intermediating dealers can extract between money market funds and hedge funds. At typical market haircut levels, traditional expected loss driven debt pricing approach can’t produce sufficient repo spreads. The so-called repo pricing puzzle, however, is explained by recognizing the critical role of repo economic capital (EC). Including cost of capital in repo pricing also explains repo maturity compression phenomenon and establishes a haircut/EC tandem that naturally stabilizes the repo market.

 

Bio: Wujiang Lou

Dr. Lou is a director trader with HSBC’s global fixed income, currently specializing in structured repo and electronic trading. He headed the US structured finance trading of the global structured credit products during the financial crisis until the legacy business was substantially unwound. Having painstakingly managed large short-term funding books during the crisis, Lou is among the first to recognize asymmetric funding cost into derivatives pricing and funding valuation adjustment (FVA) and to conduct analytic research into repo financing.  Leveraging his frontline experience of managing counterparty risk, funding and capital, Lou has conducted independent research on derivatives pricing under funding, margin, collateral and capital costs, and has published multiple technical articles covering credit, funding, margin, and capital valuation adjustments - CVA, FVA, MVA, and KVA.