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The Price of Protection: Derivatives, Default Risk, and Margining

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  • Rajna GIBSON

    (University of Geneva and Swiss Finance Institute)

  • Carsten MURAWSKI

    (The University of Melbourne)

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    Abstract

    By attaching collateral to a derivatives contract, margining supposedly reduces default risk. In this paper, we rst develop a set of testable hypotheses about the e ects of margining on banks' welfare, trading volume, and default risk in the context of a stylized banking sector equilibrium model. Subsequently, we test these hypotheses with a market simulation model. Capturing some of the main characteristics of derivatives markets, we identify stress situations in which margining has an ambiguous impact on banks' welfare, increases banks' default risk while reducing their aggregate trading volume. This is the case, in particular, when margin rates are high and collateral is scarce.

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    File URL: http://ssrn.com/abstract=1313116
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    Bibliographic Info

    Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-43.

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    Length: 61 pages
    Date of creation:
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    Handle: RePEc:chf:rpseri:rp0843

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    Web page: http://www.SwissFinanceInstitute.ch
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    Related research

    Keywords: Derivative Securities; Default Risk; Collateral; Margining; Systemic Risk.;

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