Using proprietary data from China’s interbank bond-pledged repo market, we show that the interest-rate risk and credit risk of the pledged bond are key determinants of repo pricing. From a bond-option perspective, we develop arbitrage-free models that anchor the repo yield curve to the pledged-bond yield curve. The fair repo haircut is interpreted as the per-unit price of a call option on the pledged bond. We extend this framework to incorporate bail-in or bail-out potential, which enhances the model’s empirical performance and provides a novel explanation for systematic repo cheapness and existence of negative haircuts.

How do Held-to-Maturity (HTM) securities that limit the impacts of banks’ unrealized capital loss on the regulatory capital measures affect banks’ exposure to deposit run risks when policy rates increase? And how should regulators design policies on classifying securities as HTM jointly with bank capital regulation? To answer these questions, we develop a model of bank runs in which banks classify long-term assets as HTM or Asset-for-Sale (AFS). Banks trade off the current cost of issuing equity to meet the capital requirement when the interest rate increases against increasing future run risks when the interest rate increases further in the future. When banks underestimate interest rate risks or have limited liability to depositors in the event of default, capping held-to-maturity long-term assets and mandating more equity capital issuance may reduce the run risks of moderately capitalized banks. Using bank-quarter-level data from Call Reports, we provide empirical support for the model’s testable implications.