Margining and the Stability of the Banking Sector

53 Pages Posted: 9 Dec 2008 Last revised: 3 Jan 2011

Rajna Gibson

University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute

Carsten Murawski

University of Melbourne - Department of Finance; Financial Research Network (FIRN)

Multiple version iconThere are 2 versions of this paper

Date Written: October 1, 2008

Abstract

We investigate the effects of margining, a widely-used mechanism to attach collateral to derivatives contracts, on derivatives’ trading volume, default risk, and on the welfare in the banking sector. First, we develop a stylized banking sector equilibrium model to derive a set of testable hypotheses. Subsequently, we test these hypotheses with a simulation model that captures some of the essential characteristics of over-the-counter derivatives markets. Contrarily to the common belief that margining always reduces default risk, we find that there exist situations in which margining increases default risk, reduces aggregate derivatives’ trading volume, and has an ambiguous effect on welfare in the banking sector. The negative effects of margining are exacerbated during periods of market stress when margin rates are high and collateral is scarce. We also find that central counterparties only lift some of the inefficiencies caused by margining.

Keywords: Derivative Securities, Default Risk, Collateral, Margining, Systemic Risk

JEL Classification: G19, G21

Suggested Citation

Gibson , Rajna and Murawski, Carsten, Margining and the Stability of the Banking Sector (October 1, 2008). Swiss Finance Institute Research Paper No. 08-43. Available at SSRN: https://ssrn.com/abstract=1313116 or http://dx.doi.org/10.2139/ssrn.1313116

Rajna Gibson (Contact Author)

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, 1211
Switzerland
+41.22.379.89.83 (Phone)

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Carsten Murawski

University of Melbourne - Department of Finance ( email )

Brain, Mind & Markets Lab
Parkville, Victoria 3010
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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