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

Author

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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.

Suggested Citation

  • Biais, Bruno & Heider, Florian & Hoerova, Marie, 2014. "Risk-sharing or risk-taking? An incentive theory of counterparty risk, clearing and margins," TSE Working Papers 14-522, Toulouse School of Economics (TSE).
  • Handle: RePEc:tse:wpaper:28439
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    References listed on IDEAS

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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. repec:kap:annfin:v:13:y:2017:i:4:d:10.1007_s10436-017-0308-x is not listed on IDEAS

    More about this item

    Keywords

    Hedging; Insurance; Derivatives; Moral hazard; Risk management; Counterparty risk; Contagion; Central clearing; Margin requirements;

    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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