Just curious. The daily fail to deliver issue is a $1.3 trillion disconcerting issue in the repo markets. Could it be a logical behaviour?
At some point, the implied option value of failing to deliver exceeds the penalty rate for doing so.
This inflection point in behaviour caused by increasing volatility when reached could become catastrophic having a rapid positive feedback. The rational behaviour would be for no one to deliver as the volatility went up. This would lead to failure in the repo system. Uh oh!
This is a tragedy of the liquidity commons that can only be resolved by an agreed penalty higher than the option value.
I haven't calculated the implied vol. of the overnight penalty, so don't know where the tipping point is. Any volunteers?