Risk-Sharing or Risk-Taking? Counterparty Risk, Incentives and Margins

By Bruno Biais, Florian Heider, Marie Hoerova. Social Science Research Network, 2016

122 citations recorded by the source corpus.

We analyze optimal hedging contracts and show that, although they are designed for risk–sharing, they can breed risk–taking. Bad news about the hedged risk increases the expected liability of the protection seller, undermining her own risk prevention incentives. This limits risk-sharing, creates endogenous counterparty risk and triggers contagion from news about the hedged risk to the balance sheet of the protection seller. Variation margins emerge as an optimal mechanism, which changes risk prevention incentives in addition to providing insurance against counterparty risk. Our theory implies that institutions with stronger asset base and less moral hazard should provide more protection, engage in more risk prevention, and face lower margin requirements. JEL classification: G21, G22, D82

Subfields: Accounting, Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/480f68f06d9fe34a6949932909c49b10ff926480

How researchers see this paper

The researchers whose trusted networks rank it highest, strongest advocate first. Every researcher gets a different order.

In Accounting

1. C. Calomiris
2. Florian Heider

In Economics and Econometrics

1. C. Calomiris
2. Marie Hoerova
3. Florian Heider
4. Frédéric Malherbe
5. Jie Gan

In Finance

1. Florian Heider
2. Marie Hoerova
3. C. Calomiris
4. Frédéric Malherbe
5. Thorsten Beck
6. Luc Laeven
7. Jie Gan

Citations in the corpus

• A Theory of Bank Liquidity Requirements (2015, background): “Since Bb > Bg and, by (1), Y > pY + Bb, this is a maximum expected return that can be generated if the banker does not exert effort in both aggregate states.”
• Where the Risks Lie: A Survey on Systemic Risk (2017, unknown): “Koeppl, Monnet, and Temzelides (2012) and Biais, Heider, and Hoerova (2016) analyze the optimal design of clearing arrangements, taking into account the moral hazard problem associated with counterparty risk.”