Variation margins, fire-sales and information-constrained optimality

Bruno Biais, Florian Heider and Marie Hoerova

TSE Working Papers from Toulouse School of Economics (TSE)

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 counter-party risk. Because these actions are unobservable, moral hazard limits risk sharing. To mitigate this problem, privately optimal derivative contracts involve variation mar-gins. When margins are called, protection sellers must liquidate some assets, depressing asset prices. This tightens the incentive constraints of other protection sellers and re-duces 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, con-strained efficiency; regulation (search for similar items in EconPapers)
Date: 2022-01-27
New Economics Papers: this item is included in nep-cta, nep-ias, nep-mic and nep-rmg
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Related works:
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)
Working Paper: Variation margins, fire sales, and information-constrained optimality (2018)
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