This paper introduces collateral rehypothecation, a widespread practice in derivatives, swaps, and repo markets, in a general equilibrium model with default. Rehypothecation frees up collateral because it allows lenders to resell or repledge assets pledged by borrowers. The risk that lenders will not return the asset, however, limits gains from rehypothecation. Still, when markets are contractually incomplete or decentralized, rehypothecation can achieve a superior use of scarce collateral. These results have implications for the repo market and suggest that limits to rehypothecation can cause price fragmentation.

This paper proposes a theory of excess price fluctuations in over‐the‐counter secondary markets. When heterogeneous assets trade under asymmetric information, a quality effect emerges: high liquidity lowers the quality of the pool of sellers and decreases future liquidity. Cyclical equilibria can arise even without fundamental shocks. In a cycle, investors speculate by bidding up the price of low‐quality assets, anticipating a high resale price at the peak. When this resale effect is strong, cycles disappear and multiple steady states coexist with different levels of liquidity. The model rationalizes empirical patterns for corporate bonds and housing in particular.

This article analyzes the optimal allocation of losses via a Central Clearing Counterparty (CCP) in the presence of counterparty risk. A CCP can hedge this risk by mutualizing losses among its members. This protection, however, weakens members’ incentives to manage counterparty risk. Delegating members’ risk monitoring to the CCP alleviates this tension in large markets. To discipline the CCP at minimum cost, members offer the CCP a junior tranche and demand capital contribution. Our results endogenize key layers of the default waterfall and deliver novel predictions on its composition, collateral requirements, and CCP ownership structure.

Some bank regulators require that performance bonuses for risk managers (RMs) and for employees in front offices (FOs) be linked to distinct performance metrics, as correlated pay incentives could lead RMs to rubber-stamp risky investments. We theoretically show that a positive correlation between FOs and RMs is optimal for banks, but can be socially excessive in leveraged institutions. Using data from German bank employees, we show empirically that incentive pay is indeed positively correlated between RMs and FOs. Consistent with our predictions, bonus correlations are higher in banks with higher leverage and weaker performance during the Great Financial Crisis.