A haircut is a percentage reduction applied to the market value of an asset when used as collateral for loans or margin requirements. Haircuts reflect the perceived risk, liquidity, and volatility of the underlying asset, with higher-risk assets receiving larger haircuts. This risk adjustment protects lenders and clearinghouses from potential losses if the collateral must be liquidated quickly.

Haircuts vary significantly across asset classes and market conditions, with government bonds typically receiving minimal haircuts while volatile stocks or commodities may face substantial reductions. During market stress, haircuts often increase as perceived risks rise and liquidity concerns grow. Understanding haircut policies is crucial for leverage calculations and capital allocation decisions.

Real-world example: A trader posts $1 million of corporate bonds as collateral but receives only $850,000 in borrowing capacity due to a 15% haircut applied to reflect credit and liquidity risks.