The Price of Protection: Derivatives, Default Risk, and Margining

Rajna Gibson and Carsten Murawski
Additional contact information
Rajna Gibson: University of Geneva and Swiss Finance Institute
Carsten Murawski: The University of Melbourne

No 08-43, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: By attaching collateral to a derivatives contract, margining supposedly reduces default risk. In this paper, we rst develop a set of testable hypotheses about the e ects of margining on banks' welfare, trading volume, and default risk in the context of a stylized banking sector equilibrium model. Subsequently, we test these hypotheses with a market simulation model. Capturing some of the main characteristics of derivatives markets, we identify stress situations in which margining has an ambiguous impact on banks' welfare, increases banks' default risk while reducing their aggregate trading volume. This is the case, in particular, when margin rates are high and collateral is scarce.

Keywords: Derivative Securities; Default Risk; Collateral; Margining; Systemic Risk. (search for similar items in EconPapers)
JEL-codes: G19 G21 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2008-10
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp0843

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