  A repurchase agreement lets investors borrow cash to buy securities.
Financier only lends to securities' market value after a haircut and charges
interest. Repo pricing is characterized with its puzzling dual pricing
measures: repo haircut and repo spread. This article develops a repo haircut
model by designing haircuts to achieve high credit criteria, and identifies
economic capital for repo's default risk as the main driver of repo pricing. A
simple repo spread formula is obtained that relates spread to haircuts negative
linearly. An investor wishing to minimize all-in funding cost can settle at an
optimal combination of haircut and repo rate. The model empirically reproduces
repo haircut hikes concerning asset backed securities during the financial
crisis. It explains tri-party and bilateral repo haircut differences,
quantifies shortening tenor's risk reduction effect, and sets a limit on excess
liquidity intermediating dealers can extract between money market funds and
hedge funds.
