• Equity Derivatives

    How does a repo margin affect credit-equity models?

    The repo margin that a stock owner can earn by lending her stock influences the pricing of stock derivatives. This effect is especially pronounced for distressed stocks when the repo margin is non-negligibly high. Intuitively, one might interpret the repo margin as the market’s opinion about the size of the negative drift of the stock price. This means if the repo margin is high, the market expects the stock to decline sharply. The present note explains how the repo margin enters credit-equity models which are used for detecting lucrative mispricings between credit and equity instruments of the same company, and how it affects expected income computations.