Optimal margins and equilibrium prices

Biais, Bruno, Heider, Florian and Hoerova, Marie (2017) Optimal margins and equilibrium prices. TSE Working Paper, n. 17-819, Toulouse

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Official URL: http://tse-fr.eu/pub/31769

Abstract

We study the interaction between contracting and equilibrium pricing when risk- averse hedgers purchase insurance from risk-neutral investors subject to moral hazard. Moral hazard limits risk-sharing. In the individually optimal contract, margins are called (after bad news) to improve risk-sharing. But margin calls depress the price of investors' assets, affecting other investors negatively. Because of this fire-sale externality, there is too much use of margins in the market equilibrium compared to the utilitarian optimum. Moreover, equilibrium multiplicity can arise: In a pessimistic equilibrium, hedgers who fear low prices request high margins to obtain more insurance. Large margin calls trigger large price drops, confirming initial pessimistic expectations. Finally, moral hazard generates endogenous market incompleteness, raises risk premia, and induces contagion between asset classes.

Item Type: Monograph (Working Paper)
Language: English
Date: June 2017
Place of Publication: Toulouse
Uncontrolled Keywords: Insurance, Derivatives, Moral hazard, Risk-management, Margin requirements, Contagion, Fire-sales
JEL codes: D82 - Asymmetric and Private Information
G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
G22 - Insurance; Insurance Companies
Subjects: B- ECONOMIE ET FINANCE
Divisions: TSM Research (Toulouse), TSE-R (Toulouse)
Institution: Université Toulouse 1 Capitole
Site: UT1
Date Deposited: 13 Jun 2017 13:21
Last Modified: 07 Mar 2018 13:24
OAI ID: oai:tse-fr.eu:31769
URI: http://publications.ut-capitole.fr/id/eprint/24142

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