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Variation margins, fire sales, and information-constrained optimality

Author

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  • Heider, Florian
  • Biais, Bruno
  • Hoerova, Marie
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.

Suggested Citation

  • Heider, Florian & Biais, Bruno & Hoerova, Marie, 2018. "Variation margins, fire sales, and information-constrained optimality," CEPR Discussion Papers 13192, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:13192
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    3. Wolf Wagner & Jing Zeng, 2023. "Too-many-to-fail and the Design of Bailout Regimes," ECONtribute Discussion Papers Series 230, University of Bonn and University of Cologne, Germany.
    4. Vuillemey, Guillaume, 2023. "Mitigating fire sales with a central clearing counterparty," Journal of Financial Intermediation, Elsevier, vol. 55(C).

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    More about this item

    Keywords

    Variation margins; Fire sales; Pecuniary externalities; Constrained efficiency; Macro-prudential regulation;
    All these keywords.

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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