Variation margins, fire sales, and information-constrained optimality

Bruno Biais, Florian Heider and Marie Hoerova

No 2191, Working Paper Series from European Central Bank

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. JEL Classification: G18, D62, G13, D82

Keywords: constrained efficiency; fire sales; macro-prudential regulation; pecuniary externalities; variation margins (search for similar items in EconPapers)
Date: 2018-10
New Economics Papers: this item is included in nep-cta
Note: 276127
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Variation margins, fire-sales and information-constrained optimality (2022)
Journal Article: Variation Margins, Fire Sales, and Information-constrained Optimality (2021)
Working Paper: Variation margins, fire-sales and information-constrained optimality (2021)
Working Paper: Variation margins, fire sales, and information-constrained optimality (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20182191

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