Variation Margins, Fire Sales, and Information-Constrained Optimum

Review of Economic Studies, accepted for publication

78 Pages Posted: 30 Nov 2015 Last revised: 24 Apr 2020

See all articles by Bruno Biais

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)

Multiple version iconThere are 2 versions of this paper

Date Written: April 23, 2020

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 counterparty risk. Because these actions are unobservable, moral hazard limits risk sharing. To mitigate this problem, privately optimal derivative contracts involve variation margins. When margins are called, protection sellers must liquidate some assets, depressing asset prices. This tightens the incentive constraints of other protection sellers and reduces their ability to provide insurance. Despite this fire-sale externality, equilibrium is information-constrained efficient. Investors, who benefi t 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, constrained efficiency, 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 (April 23, 2020). Review of Economic Studies, accepted for publication, 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 )

London
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 )

London
United Kingdom

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