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Persistence and Procyclicality in Margin Requirements

Author

Listed:
  • Paul Glasserman

    (Office of Financial Research)

  • Qi Wu

    (Chinese University of Hong Kong)

Abstract

Margin requirements for derivative contracts serve as a buffer against the transmission of losses through the financial system by protecting one party to a contract against default by the other party. However, if margin levels are proportional to volatility, then a spike in volatility leads to potentially destabilizing margin calls in times of market stress. Risk-sensitive margin requirements are thus procyclical in the sense that they amplify shocks. We use a GARCH model of volatility and a combination of theoretical and empirical results to analyze how much higher margin levels need to be to avoid procyclicality while reducing counterparty credit risk. Our analysis compares the tail decay of conditional and unconditional loss distributions to compare stable and risk-sensitive margin requirements. Greater persistence and burstiness in volatility leads to a slower decay in the tail of the unconditional distribution and a higher buffer needed to avoid procyclicality. The tail decay drives other measures of procyclicality as well. Our analysis points to important features of price time series that should inform "anti-procyclicality" measures but are missing from current rules.

Suggested Citation

  • Paul Glasserman & Qi Wu, 2017. "Persistence and Procyclicality in Margin Requirements," Working Papers 17-01, Office of Financial Research, US Department of the Treasury.
    • Handle: RePEc:ofr:wpaper:17-01
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    References listed on IDEAS

    as
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    Cited by:

    1. Elena Goldman & Xiangjin Shen, 2018. "Analysis of Asymmetric GARCH Volatility Models with Applications to Margin Measurement," Staff Working Papers 18-21, Bank of Canada.
    2. Melinda Friesz & Kira Muratov-Szabó & Andrea Prepuk & Kata Váradi, 2021. "Risk Mutualization in Central Clearing: An Answer to the Cross-Guarantee Phenomenon from the Financial Stability Viewpoint," Risks, MDPI, vol. 9(8), pages 1-19, August.

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    More about this item

    Keywords

    Margin Requirements; Derivatives Contracts; Margin Calls; Cycles; Volatility; GARCH; Financial Shocks; Transmission of Losses;
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