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Risk‐Sharing or Risk‐Taking? Counterparty Risk, Incentives, and Margins
Author(s) -
BIAIS BRUNO,
HEIDER FLORIAN,
HOEROVA MARIE
Publication year - 2016
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12396
Subject(s) - counterparty , incentive , business , credit risk , asset (computer security) , actuarial science , liability , margin (machine learning) , financial risk management , risk management , risk analysis (engineering) , economics , microeconomics , finance , computer security , computer science , machine learning
Derivatives activity, motivated by risk‐sharing, can breed risk‐taking. Bad news about the risk of an asset underlying a derivative increases protection sellers' expected liability and undermines their risk‐prevention incentives. This limits risk‐sharing, creates endogenous counterparty risk, and can lead to 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 in turn enhance risk‐sharing. Central clearing can provide insurance against counterparty risk but must be designed to preserve risk‐prevention incentives.