Bilateral Counterparty Risk under Funding Constraints

2014 ◽  
pp. 107-134
Keyword(s):  
Counterparty Risk

scholarly journals Variation margins, fires sales, and information-constrained optimality

2020 ◽  
Author(s):  
Bruno Biais ◽  
Florian Heider ◽  
Marie Hoerova
Keyword(s):  
Moral Hazard ◽  
Risk Sharing ◽  
Asset Prices ◽  
Counterparty Risk ◽  
Fire Sales ◽  
Risk Protection ◽  
Incentive Constraints

Abstract In order to share risk, protection buyers trade derivatives with protection sellers. Protection sellers’ actions affect the riskiness of their assets, which can create counterparty risk. Because these actions are unobservable, moral hazard limits risk sharing. To mitigate this problem, privately optimal derivative contracts involve variation margins. When margins are called, protection sellers must liquidate some assets, depressing asset prices. This tightens the incentive constraints of other protection sellers and reduces their ability to provide insurance. Despite this fire-sale externality, equilibrium is information-constrained efficient. Investors, who benefit from buying assets at fire-sale prices, optimally supply insurance against the risk of fire sales.

PRICING COUNTERPARTY RISK INCLUDING COLLATERALIZATION, NETTING RULES, RE-HYPOTHECATION AND WRONG-WAY RISK

2013 ◽  
Vol 16 (02) ◽  
pp. 1350007 ◽  
Author(s):  
DAMIANO BRIGO ◽  
AGOSTINO CAPPONI ◽  
ANDREA PALLAVICINI ◽  
VASILEIOS PAPATHEODOROU
Keyword(s):  
Interest Rate ◽  
Credit Derivatives ◽  
Credit Default Swaps ◽  
Credit Spread ◽  
Counterparty Risk ◽  
Default Correlation ◽  
Dynamical Models ◽  
Credit Default ◽  
The Impact

This article is concerned with the arbitrage-free valuation of bilateral counterparty risk through stochastic dynamical models when collateral is included, with possible rehypothecation. The payout of claims is modified to account for collateral margining in agreement with International Swap and Derivatives Association (ISDA) documentation. The analysis is specialized to interest-rate and credit derivatives. In particular, credit default swaps are considered to show that a perfect collateralization cannot be achieved under default correlation. Interest rate and credit spread volatilities are fully accounted for, as is the impact of re-hypothecation, collateral margining frequency, and dependencies.

scholarly journals Time versus State in Insurance: Experimental Evidence from Contract Farming in Kenya

2018 ◽  
Vol 108 (12) ◽  
pp. 3778-3813 ◽  
Author(s):  
Lorenzo Casaburi ◽  
Jack Willis
Keyword(s):  
Crop Insurance ◽  
Counterparty Risk ◽  
Harvest Time ◽  
Contract Farming ◽  
Present Bias ◽  
The Poor ◽  
Percentage Points ◽  
Randomized Control ◽  
The Difference

The gains from insurance arise from the transfer of income across states. Yet, by requiring that the premium be paid up front, standard insurance products also transfer income across time. We show that this intertemporal transfer can help explain low insurance demand, especially among the poor, and in a randomized control trial in Kenya we test a crop insurance product which removes it. The product is interlinked with a contract farming scheme: as with other inputs, the buyer of the crop offers the insurance and deducts the premium from farmer revenues at harvest time. The take-up rate for pay-at-harvest insurance is 72 percent, compared to 5 percent for the standard pay-up-front contract, and the difference is largest among poorer farmers. Additional experiments and outcomes provide evidence on the role of liquidity constraints, present bias, and counterparty risk, and find that enabling farmers to commit to pay the premium just 1 month later increases demand by 21 percentage points. (JEL G22, I32, O13, O16, Q12, Q14)

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