Risk-sharing or risk-taking? An incentive theory of counterparty risk, clearing and margins

Bruno Biais, Florian Heider and Marie Hoerova

No 834, IDEI Working Papers from Institut d'Économie Industrielle (IDEI), Toulouse

Abstract: Derivatives activity, motivated by risk-sharing, can breed risk taking. Bad news about the risk of the asset underlying the derivative increases the expected liability of a protection seller and undermines her risk prevention incentives. This limits risk-sharing, and may create endogenous counterparty risk and contagion from news about the hedged risk to the balance sheet of protection sellers. Margin calls after bad news can improve protection sellers incentives and enhance the ability to share risk. Central clearing can provide insurance against counterparty risk but must be designed to preserve risk-prevention incentives.

Keywords: Hedging; Insurance; Derivatives; Moral hazard; Risk management; Counterparty risk; Contagion; Central clearing; Margin requirements (search for similar items in EconPapers)
JEL-codes: D82 G21 G22 (search for similar items in EconPapers)
Date: 2014-06
New Economics Papers: this item is included in nep-cta, nep-fmk, nep-hrm and nep-ias
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Working Paper: Risk-sharing or risk-taking? An incentive theory of counterparty risk, clearing and margins (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ide:wpaper:25522

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