Game theory in Repo markets..

I have always been thinking about how game theory can be used to understand repo markets. I mean it is a classic market for applying game theory ideas given the dynamic nature of both the fields.

Somebody has surplus funds, somebody has securities to offer. Should the lender offer funds to the bank or to the central bank? Should the borrower borrow from markets or central bank?

Huberto Ennis of Richmond Fed provides some ways to look at the issues in this paper:

In this article, we study a simple model of the tri-party repo arrangement that allows us to capture in a parsimonious way some of the strategic interactions that arise in this market. In our analysis, we use standard non-cooperative game theory to uncover the basic mechanisms that can create some of the vulnerabilities commonly attributed to the tri-party repo market. We will show that a change in perceptions can create a sudden coordinated withdrawal of lenders from this market. Also, we will highlight the crucial role that the clearing bank plays in this game of “withdrawing before the rest,” which appears to be a good representation of the situation that was present in the tri-party repo market during the recent financial crisis.

I do not understand game theory much so need to read this paper many times. Hence no comments. Happy to see some research on the area. Understanding game theory could be easier looking at repo markets..

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