The discount applied to collateral's market value when calculating how much credit it supports, sized to cover potential price falls before the collateral could be sold.
Pledging $10 million of a security with a 5% haircut supports $9.5 million of borrowing. Government bonds attract haircuts of a percent or two; equities and lower-quality credit attract far more; illiquid or volatile assets may not be eligible at all.
Haircuts are procyclical, which is the core problem. They are low when volatility is low and rise sharply in stress, forcing borrowers to post more collateral or reduce positions exactly when prices are falling. That feedback loop amplified the deleveraging in 2008 and in March 2020.
For a leveraged strategy, the haircut schedule effectively sets maximum leverage, and its sensitivity to volatility sets how quickly that maximum can shrink. Stress the schedule, not just the prices. See collateral and margin-call.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Margin and leverage. A $5,000 deposit can control a $100,000 position, which is 20:1 leverage. Because the loss is measured on the full $100,000, a 2.5% move against you halves the deposit and brings a margin call, and a 5% move uses all of it.Buying a call: payoff at expiry. A 105-strike call bought for 3 loses that whole 3 if the price finishes at or below 105, breaks even at 108, then gains a dollar for every dollar higher. The loss is capped at the premium; the upside is not capped.
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