Foundational Confidence: 100% ·Mar 10, 2026

Collateralized Lending Risk (Jump-to-Default + Liquidation Loss)

Last Updated: 2026-01-27

This document covers risk for collateralized lending positions where losses arise from fast price moves, liquidation mechanics, and execution/oracle constraints (as opposed to pull-to-par duration mechanics).

Core Question

In a stressed event, what loss can occur before liquidations can restore solvency?

This is the “gap risk / liquidation shortfall” capital component.

Components

1) Jump-to-Default / Price Gap

Collateral can move discontinuously (or effectively discontinuously relative to liquidation throughput), creating undercollateralized positions.

2) Liquidation Loss Given Default (LGD)

Even if liquidations execute, realized loss can be amplified by:

  • auction slippage / AMM depth
  • oracle latency or failure modes
  • congestion and delayed keepers
  • collateral correlation (everyone selling the same collateral)

3) Protocol/Mechanism Risk

Even with adequate collateralization, failures can create loss:

  • smart contract bugs
  • oracle manipulation / stale feeds
  • governance/key compromise (where relevant)

Gap Risk Capital (Current Placeholder)

Gap risk is the bad debt that occurs when collateral prices crash faster than liquidations can execute.

Approach:

  1. Analyze historical crash data (flash crashes, black swan events)
  2. Model health factor distribution under stress — not assuming all positions jump to HF=1
  3. Calculate expected bad debt for instantaneous price gaps of X% (derived from historical worst cases)
  4. Size capital to survive the worst-case scenario at chosen confidence level

Key insight: The distribution matters — some positions are well-overcollateralized, others are marginal.

Outputs

  • gap_risk_CRR (capital ratio requirement for collateralized lending exposures)
  • Optional: breakouts for jump_risk, liquidation_LGD, and mechanism_risk if we want a more granular reporting model

Combination Rule

gap_risk_CRR is the forced-liquidation / shortfall capital term for collateralized lending exposures. In the capital formula it is combined with fundamental risk (risk weight) via a loss envelope:

Position Capital = Position Size × max(Risk Weight, Gap Risk CRR)

See capital-formula.md for how this connects to other asset types.

Connections

  • Capital composition: capital-formula.md
  • Asset examples: asset-type-treatment.md