Jean-Marc Bottazzi

Securities market theory: Possession, repo and rehypothecation

By introducing repo markets we understand how agents need to borrow issued securities before shorting them: (re)-hypothecation is at the heart of shorting. Non-negative amounts of securities in the box of an agent (amounts borrowed or owned but not lent on) can be sold, and recursive use of securities as collateral allows agents to leverage their positions. A binding box constraint induces a liquidity premium: the repo rate becomes special and the security price higher than expected discounted cash-flows. Existence of equilibrium is guaranteed under limited re-hypothecation, a situation secured by (current or proposed) institutional arrangements.

Accessibility of Pareto optima by Walrasian exchange processes

Abstract Every individually rational Pareto optimum is the limit of a Walrasian exchange process: a procedure where consumers engage continuosly in a myopic competitive infinitesimal exchange. Every Pareto optimum is the limit of essentially bilateral exchanges and thus the limit of essentially bilateral barter. There is more: the exchange sometimes even has to be essentially bilateral. The construction of exchanges is explicit. Yet, the conditions required to attain some Pareto optima are shown to necessarily be very demanding, so demanding indeed that in sum non neutrality can be considered as the rule, even with myopic agents.

Existence of equilibria with incomplete markets: The case of smooth returns

Abstract The aim of this paper is to study a two-period incomplete market general equilibrium model with yields depending regularly on spot price. As the asset space is big, so are its exeptional sets and we will carefully exhibit a generic class of ‘good’ asset structures for which an equilibrium exists for generic endowments. This class of asset structure formalises the idea that asset structures for which there is a robust existence problem (cf. Ku and Polemarchakis (1990)), have ‘sticky’ critical prices.

A market game for assets and taxed investors

Abstract We think of tax regimes faced by distinct investors as different after-tax price systems and construct a simple linear economy. After-tax pricing rules are mapped to linear utilities and access to leverage (understood as the ability to sell) to initial endowments. We find that if one type has much greater access to financial leverage than the rest of the economy (think of this type as the financial sector) s/he has no trading benefit in the perfectly competitive framework ( Boiteux Monopoly). We therefore introduce imperfect competition: while best execution makes the dictatorial Pareto optimum associated with the monopoly typically unattainable, this monopolistic equilibrium may be non Pareto optimal. Introducing oligopolistic equilibria with competition in quantity, we show on an example how equilibria become competitive when the number of competitors increases.

Market Demand Functions in the CAPM

In this book we study the CAPM as a general equilibrium model in which the natural questions of existence and uniqueness of an equilibrium play an important role. Similar to Nielsen [1990b] and Allingham [1991] in the previous chapter we have given general proofs of existence within this framework where consumption sets are not bounded below and satiation is possible. As shown by an example with two equilibria constructed by Nielsen [1988], there is, however, no reason to expect uniqueness in general. We will continue along this line of research and will analyze the structure of market demand in the CAPM. We will show that given any choice of a finite number of normalized price systems and the respective demands satisfying Walras’ Law and the Tobin Separation Property, there exist two variance-averse agents whose market demand coincides with the preassigned values. This result parallels the result proved in Chapter 3 which itself was a generalization of results known in the general equilibrium literature as the Sonnenschein-Mantel-Debreu result on the structure of market excess demand functions. The result proved in this chapter for the CAPM considers the market excess demand function on a finite set of prices which is then similar to the result of Andreu [1982].

Dollar Shortage, Central Bank Actions, and the Cross Currency Basis

In our model, cross-currency basis, which captures the deviations from covered interest rate parity (CIP), reflects the relative value of the scarcer currency (US dollar) as collateral in funding constraints. Our empirical evidence shows that measures of dollar shortage derived from ECB tenders, and actions to move to fixed-rate tenders with full allotment and to expand the eligible collateral by the ECB have significant power in explaining the cross currency basis. We show that the relaxation of Euro funding constraints through 3-year Long Term Re-financing Operations (LTROs) does not contribute to the narrowing of the cross-currency basis, consistent with the theory developed in the paper.