Variation margins, fire sales, and information-constrained optimality

Florian Heider, Bruno Biais and Marie Hoerova

No 13192, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Protection buyers use derivatives to share risk with protection sellers, whose assets are only imperfectly pledgeable because of moral hazard. To mitigate moral hazard, privately optimal derivative contracts involve variation margins. When margins are called, protection sellers must liquidate some of their own assets. We analyse, in a general-equilibrium framework, whether this leads to inefficient fire sales. If investors buying in a fire sale interim can also trade ex ante with protection buyers, equilibrium is information-constrained efficient even though not all marginal rates of substitution are equalized. Otherwise, privately optimal margin calls are inefficiently high. To address this inefficiency, public policy should facilitate ex-ante contracting among all relevant counterparties.

Keywords: Variation margins; Fire sales; Pecuniary externalities; Constrained efficiency; Macro-prudential regulation (search for similar items in EconPapers)
JEL-codes: D62 D82 G13 G18 (search for similar items in EconPapers)
Date: 2018-09
New Economics Papers: this item is included in nep-cta, nep-gth and nep-mic
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Variation margins, fire-sales and information-constrained optimality (2022)
Journal Article: Variation Margins, Fire Sales, and Information-constrained Optimality (2021)
Working Paper: Variation margins, fire-sales and information-constrained optimality (2021)
Working Paper: Variation margins, fire sales, and information-constrained optimality (2018)
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