Risk-Sharing or Risk-Taking? Counterparty Risk, Incentives and Margins

80 Pages Posted: 16 Mar 2010 Last revised: 11 Sep 2015

Bruno Biais

Centre for Economic Policy Research (CEPR)

Florian Heider

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Marie Hoerova

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: July 17, 2015

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: Hedging, Insurance, Derivatives, Moral hazard, Risk management, Counterparty risk, Contagion, Margin requirements

JEL Classification: G21, G22, D82

Suggested Citation

Biais, Bruno and Heider, Florian and Hoerova, Marie, Risk-Sharing or Risk-Taking? Counterparty Risk, Incentives and Margins (July 17, 2015). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1571065 or http://dx.doi.org/10.2139/ssrn.1571065

Bruno Biais

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Florian Heider

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

HOME PAGE: http://https://sites.google.com/site/florianheider2/

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Marie Hoerova (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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