How confident are we of margin model procyclicality measurements?

20 Pages Posted: 20 Mar 2023 Last revised: 30 Jan 2024

Date Written: March 20, 2023

Abstract

Measuring the responsiveness of a market risk model is relevant whenever the focus is on evaluating if a model is over- or under-reacting to changes in market conditions. Such is the case, for example, in the discussion about procyclical effects of the initial margin models used both in the centrally cleared and non-centrally cleared worlds to estimate the potential future exposure of portfolios. By definition, these models are sensitive to changes in market risk and, as a consequence, when market risk increases, initial margin requirements will tend to increase. To mitigate procyclical effects, CCPs have put in place different procyclicality mitigation tools across their risk management arrangements. However, after the Covid-19 stress, there have been renewed discussions about further monitoring, measuring, and mitigation of models' procyclicality. This paper contributes to the discussion by bringing the attention to the fact that the standard measures of model responsiveness are random variables and, as such, are subject to uncertainty. Therefore, any decision or policy making that is based on these measures requires, to be robust, to take into consideration the impact that uncertainty will have on expected outcomes. To estimate such impact, the analysis examines the case of some typical margin models, both empirically and within a Monte Carlo simulation setting. The results show there is a significant amount of uncertainty when measuring responsiveness, which raises questions about the effectiveness of model-focused, hard-rule approaches to procyclicality.

Keywords: Central counterparties (CCPs), procyclicality, initial margin (IM), margin models, filtered historical simulation

JEL Classification: G17, C60, G23, G01

Suggested Citation

Gurrola Perez, Pedro, How confident are we of margin model procyclicality measurements? (March 20, 2023). Proceedings of WFEClear: The WFE’s Clearing & Derivatives Conference 2023, Available at SSRN: https://ssrn.com/abstract=4394462 or http://dx.doi.org/10.2139/ssrn.4394462

Pedro Gurrola Perez (Contact Author)

World Federation of Exchanges ( email )

125 Old Broad Street
London, EC2N 1AR
United Kingdom
EC2N 1AR (Fax)

HOME PAGE: http://www.world-exchanges.org

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