Variation margins, fire sales, and information-constrained optimum

60 Pages Posted: 30 Nov 2015 Last revised: 30 Aug 2018

Bruno Biais

University of Toulouse 1 - Toulouse School of Economics (TSE)

Florian Heider

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

Marie Hoerova

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

Date Written: May 17, 2018

Abstract

Protection buyers use derivatives to share risk with protection sellers, whose assets are only imperfectly pledgeable because of moral hazard. To mitigate moral hazard, privately optimal derivative contracts involve variation margins. When margins are called, protection sellers must liquidate some of their own assets. We analyse, in a general-equilibrium framework, whether this leads to inefficient fire sales. If investors buying in a fire sale interim can also trade ex ante with protection buyers, equilibrium is information-constrained efficient even though not all marginal rates of substitution are equalized. Otherwise, privately optimal margin calls are inefficiently high. To address this inefficiency, public policy should facilitate ex-ante contracting among all relevant counterparties.

Keywords: variation margins, fire sales, pecuniary externalities, constrained efficiency, macro-prudential regulation

JEL Classification: G18, D62, G13, D82

Suggested Citation

Biais, Bruno and Heider, Florian and Hoerova, Marie, Variation margins, fire sales, and information-constrained optimum (May 17, 2018). Available at SSRN: https://ssrn.com/abstract=2696439 or http://dx.doi.org/10.2139/ssrn.2696439

Bruno Biais

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

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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