Fit for SIMM: Initial Margin Forecasting with Stochastic Cross-currency Basis

Abstract

A common shortcut to forecasting initial margin requirements and margin valuation adjustments that are aligned with the International Swaps and Derivatives Association's Standard Initial Margin Model relies on simulating and recalibrating value-at-risk quantiles. Doing so largely avoids costly sensitivity calculations but works only if the relevant risks are appropriately represented in the simulation model. In this paper, we highlight the impact of missing cross-currency basis risk factors on estimating initial margin and margin valuation adjustments for cross-currency basis sensitive instruments. We propose a parsimonious, consistent, and efficient stochastic cross-currency basis model extension as remedy and provide illustrative examples. The examples cover vanilla interest rate swaps and resetting and non-resetting cross-currency basis swaps in currencies CAD, EUR, JPY, and USD. In addition to initial margin and margin valuation adjustment, we also compute and compare the impact on residual credit valuation adjustment.

Keywords: Standard Initial Margin Model (SIMM), initial margin (IM), stochastic cross-currency basis, margin valuation adjustment (MVA), credit valuation adjustment (CVA), Hull-White model

JEL Classification: G