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.

Incentive problems make securities’ payoffs imperfectly pledgeable, limiting agents’ ability to issue liabilities. We analyze the equilibrium consequences of such endogenous incompleteness in a dynamic exchange economy. Because markets are endogenously incomplete, agents have different intertemporal marginal rates of substitution, so that they value assets differently. Consequently, agents hold different portfolios. This leads to endogenous markets segmentation, which we characterize with optimal transport methods. Moreover, there is a basis going always in the same direction: the price of a security is lower than that of replicating portfolios of long positions. Finally, equilibrium expected returns are concave in factor loadings.