Clearing House, Margin Requirements, and Systemic Risk

Abstract

Margins are the major safeguards against default risk on a derivatives exchange. When the clearing house sets margin requirements, it does so by only focusing on individual clearing firm positions (e.g., the SPAN system). We depart from this traditional approach and present an alternative method that accounts for inter-dependencies among clearing members when setting margins. Our method generalizes the SPAN system by allowing individual margins to increase when clearing firms are more likely to be in financial distress simultaneously.

Keywords: derivatives, tail risk, default risk, extreme dependence, copulas

JEL Classification: G13