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Risk-sharing or risk-taking? An incentive theory of counterparty risk, clearing and margins

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

Abstract

Derivatives activity, motivated by risk-sharing, can breed risk taking. Bad news about the risk of the asset underlying the derivative increases the expected liability of a protection seller and undermines her risk prevention incentives. This limits risk-sharing, and may create endogenous counterparty risk and contagion from news about the hedged risk to the balance sheet of protection sellers. Margin calls after bad news can improve protection sellers incentives and enhance the ability to share risk. Central clearing can provide insurance against counterparty risk but must be designed to preserve risk-prevention incentives.

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  • Biais, Bruno & Heider, Florian & Hoerova, Marie, 2014. "Risk-sharing or risk-taking? An incentive theory of counterparty risk, clearing and margins," IDEI Working Papers 834, Institut d'Économie Industrielle (IDEI), Toulouse.
    • Handle: RePEc:ide:wpaper:25522
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    Cited by:

    1. Albert Menkveld & Emiliano Pagnotta & Marius Andrei Zoican, 2016. "Does Central Clearing Affect Price Stability? Evidence from Nordic Equity Markets," Working Papers hal-01253702, HAL.
    2. Agostino Capponi & W. Allen Cheng & Sriram Rajan, 2015. "Systemic Risk: The Dynamics under Central Clearing," Working Papers 15-08, Office of Financial Research, US Department of the Treasury.
    3. Binbin Deng, 2017. "Counterparty risk, central counterparty clearing and aggregate risk," Annals of Finance, Springer, vol. 13(4), pages 355-400, November.

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    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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