Risk-sharing or risk-taking? Counterparty-risk, incentives and margins

Bruno Biais, Florian Heider and Marie Hoerova

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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: Asymmetric and Private Information Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages Insurance; Insurance Companies (search for similar items in EconPapers)
Date: 2016
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Published in Journal of Finance, 2016, 71 (4), pp.1669-1698. ⟨10.1111/jofi.12396⟩

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Related works:
Journal Article: Risk-Sharing or Risk-Taking? Counterparty Risk, Incentives, and Margins (2016)
Working Paper: Risk-sharing or risk-taking? Counterparty risk, incentives and margins (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:halshs-01520953

DOI: 10.1111/jofi.12396

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