Variation Margins, Fire Sales, and Information-Constrained Optimality
SpeakerFlorian Heider (European Central Bank)
LocationTinbergen Institute, Room 1.60
Date and time
September 18, 2019
12:45 - 14:00
In order to share risk, protection buyers trade derivatives with protection sellers.
Protection sellers' actions aect the riskiness of their assets and therefore counterparty
risk. Because these actions are unobservable there is moral hazard, which hinders 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, reducing their ability to provide insurance. Despite such externalities, equilibrium is information-constrained ecient as investors, who benet from re sales in which they buy underpriced assets, optimally supply insurance against the risk of fire sales.
Joint with Bruno Biais (HEC), Marie Hoerova (ECB).