Biais, Bruno, Heider, Florian and Hoerova, Marie (2022) Variation margins, fire-sales and information-constrained optimality. TSE Working Paper, n. 22-1296, Toulouse

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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.

Item Type: Monograph (Working Paper)
Language: English
Date: January 2022
Place of Publication: Toulouse
Uncontrolled Keywords: variation margins, fire sales, pecuniary externality, moral hazard, con-strained efficiency, regulation
JEL Classification: D62 - Externalities
D82 - Asymmetric and Private Information
G13 - Contingent Pricing; Futures Pricing
G18 - Government Policy and Regulation
Divisions: TSE-R (Toulouse)
Institution: Université Toulouse 1 Capitole
Site: UT1
Date Deposited: 31 Jan 2022 10:09
Last Modified: 31 Jan 2022 10:09
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