Variation Margins, Fire Sales, and Information-constrained Optimality

Leverage, Moral Hazard, and Liquidity

Bruno Biais, Florian Heider and Marie Hoerova

The Review of Economic Studies, 2021, vol. 88, issue 6, 2654-2686

Abstract: In order to share risk, protection buyers trade derivatives with protection sellers. Protection sellers’ actions affect the riskiness of their assets, which can create counterparty risk. Because these actions are unobservable, moral hazard limits risk sharing. To mitigate this problem, privately optimal derivative contracts involve variation margins. When margins are called, protection sellers must liquidate some assets, depressing asset prices. This tightens the incentive constraints of other protection sellers and reduces their ability to provide insurance. Despite this fire-sale externality, equilibrium is information-constrained efficient. Investors, who benefit from buying assets at fire-sale prices, optimally supply insurance against the risk of fire sales.

Keywords: Variation margins; Fire sales; Pecuniary externality; Moral hazard; Constrained efficiency; Regulation; G18; D62; G13; D82 (search for similar items in EconPapers)
Date: 2021
References: Add references at CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
http://hdl.handle.net/10.1093/restud/rdaa083 (application/pdf)
Access to full text is restricted to subscribers.

Related works:
Working Paper: Variation margins, fire-sales and information-constrained optimality (2022)
Working Paper: Variation margins, fire-sales and information-constrained optimality (2021)
Working Paper: Variation margins, fire sales, and information-constrained optimality (2018)
Working Paper: Variation margins, fire sales, and information-constrained optimality (2018)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:oup:restud:v:88:y:2021:i:6:p:2654-2686.

Access Statistics for this article

The Review of Economic Studies is currently edited by Thomas Chaney, Xavier d’Haultfoeuille, Andrea Galeotti, Bård Harstad, Nir Jaimovich, Katrine Loken, Elias Papaioannou, Vincent Sterk and Noam Yuchtman

More articles in The Review of Economic Studies from Review of Economic Studies Ltd
Bibliographic data for series maintained by Oxford University Press ().