Variation Margins, Fire Sales, and Information-Constrained Optimality

63 Pages Posted: 24 Sep 2018

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: September 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: constrained efficiency, fire sales, macro-prudential regulation, Pecuniary externalities, variation margins

JEL Classification: D62, D82, G13, G18

Suggested Citation

Biais, Bruno and Heider, Florian and Hoerova, Marie, Variation Margins, Fire Sales, and Information-Constrained Optimality (September 2018). CEPR Discussion Paper No. DP13192, Available at SSRN: https://ssrn.com/abstract=3254227

Bruno Biais (Contact Author)

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

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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