Credit Exposure in the Presence of Initial Margin

Leif B. G. Andersen

Bank of America Merrill Lynch

Michael Pykhtin

Board of Governors of the Federal Reserve System

Alexander Sokol


July 22, 2016

We leverage the new framework for collateralized exposure modelling in Andersen, Pykhtin, and Sokol (2016) to analyze credit risk on positions collateralized with both variation and initial margin. Special attention is paid to the dynamic BCBS-IOSCO uncleared margin requirements soon to be mandated for bilateral inter-dealer trading in OTC derivatives markets. While these requirements aim to eliminate portfolio close-out risk at the 99th 2-week percentile level, we demonstrate that trade flow effects can result in exposures being reduced significantly less than expected. For example, for a standard fixed-floating interest rate swap, we show in a numerical example that adding initial margin to zero-threshold variation margin may reduce CVA only by a factor of around 4-6. In contrast, theoretical results that exclude trade flow effects will, as we show, predict idealized reductions of approximately x120 for a broad class of risk factor diffusion processes. As proper identification of exposure in the presence of initial margin can be computationally demanding, we supplement our analysis with several practical schemes for speeding up Monte Carlo simulation, estimating IM on a simulation path, and calculating stable and accurate expected exposure numbers. We also briefly discuss potential ways to adjust the margin framework to better deal with exposures arising from trade flow events.

Number of Pages in PDF File: 18

Keywords: margin period of risk, initial margin, credit exposure, uncleared margin rules, kernel regression

JEL Classification: G10, G13, G20, G33, C15

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Date posted: July 8, 2016 ; Last revised: August 18, 2016

Suggested Citation

Andersen, Leif B. G. and Pykhtin, Michael and Sokol, Alexander, Credit Exposure in the Presence of Initial Margin (July 22, 2016). Available at SSRN: https://ssrn.com/abstract=2806156

Contact Information

Leif B.G. Andersen (Contact Author)
Bank of America Merrill Lynch ( email )
One Bryant Park
New York, NY 10036
United States
646-855-1835 (Phone)
Michael Pykhtin
Board of Governors of the Federal Reserve System ( email )
20th Street and Constitution Avenue NW
Washington, DC 20551
United States
HOME PAGE: http://www.federalreserve.gov/econresdata/michael-v-pykhtin.htm

Alexander Sokol
CompatibL ( email )
100 Overlook Center
Second Floor
Princeton, NJ 08540
United States
HOME PAGE: http://www.compatibl.com
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