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Optimal margins and equilibrium prices

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  • Bruno Biais

    (Université de Toulouse 1 Capitole)

Abstract

We study the interaction between contracting and equilibrium pricing when risk- averse hedgers purchase insurance from risk-neutral investors subject to moral hazard. Moral hazard limits risk-sharing. In the individually optimal contract, margins are called (after bad news) to improve risk-sharing. But margin calls depress the price of investors' assets, affecting other investors negatively. Because of this re-sale ex- ternality, there is too much use of margins in the market equilibrium compared to the utilitarian optimum. Moreover, equilibrium multiplicity can arise: In a pessimistic equilibrium, hedgers who fear low prices request high margins to obtain more insurance. Large margin calls trigger large price drops, confirming initial pessimistic expectations. Finally, moral hazard generates endogenous market incompleteness, raises risk premia, and induces contagion between asset classes.

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  • Bruno Biais, 2016. "Optimal margins and equilibrium prices," 2016 Meeting Papers 270, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:270
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    References listed on IDEAS

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    Cited by:

    1. Koenig, Philipp J. & Pothier, David, 2022. "Safe but fragile: Information acquisition, liquidity support and redemption runs," Journal of Financial Intermediation, Elsevier, vol. 52(C).

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    More about this item

    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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