Simple Way of Conservatively Estimating Credit Exposure under Dynamic Initial Margins

11 Pages Posted: 10 Jul 2019

Date Written: July 8, 2019

Abstract

It is now common to use dynamic initial margins (DIM) to offset counterparty credit risk in listed, cleared and OTC derivative markets as well as prime brokerages. Typically those initial margins are designed to cover counterparty portfolio value move during margin period of risk (MPOR) period of 10 business days at least at the level of 99% percentile. If DIM is calibrated to stress time period percentile would be even higher for current levels of volatilities. Brute force model calculation in this case of residual small potential future exposure (PFE) is rather cumbersome and inefficient numerically. Here we propose instead of computing residual future potential exposure just set it equal to a fixed proportion of future DIM computed according to PFE model. Estimating future DIM is generally easier problem than computing PFE under high DIM. We argue that using 1% of future model consistent DIM will be sufficiently conservative estimation of PFE. We also argue that the only consistent way to handle future DIM would be using the same model used for PFE calculation, provided it could be demonstrated that this model is conservative enough but less conservative then DIM model. This way future DIM also could be conservatively estimated as 99% of unconditional counterparty portfolio move during MPOR within the model used. With this simple proposal one can use existing PFE framework with minimum modification for computing PFE under DIM.

Keywords: Dynamic Initial Margins, Counterparty Credit Risk, CVA, MVA, OTC, SIMM, SA-CCR, Financial Regulation

JEL Classification: G15, G18, G24, G28, G32, G38

Suggested Citation

Borue, Vadim, Simple Way of Conservatively Estimating Credit Exposure under Dynamic Initial Margins (July 8, 2019). Available at SSRN: https://ssrn.com/abstract=3416512 or http://dx.doi.org/10.2139/ssrn.3416512

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