Haircut Volatility

Haircut volatility refers to the fluctuating percentage reduction applied to the value of an asset when it is used as collateral. Lenders apply a haircut to protect themselves against the risk that the asset's market value will drop, leaving them with insufficient collateral to cover a loan.

When market volatility increases, lenders often increase these haircuts to compensate for the higher risk, effectively forcing borrowers to provide more collateral. This dynamic can trigger a cycle of forced selling, as borrowers struggle to meet the new, higher requirements.

It acts as a transmission mechanism for market stress, where changes in collateral quality requirements exacerbate price swings. Understanding this is crucial for participants managing leveraged positions.