An Investigation into the Procyclicality of Risk-Based Initial Margin Models

Murphy, David; Vasios, Michalis; Vause, Nick

doi:10.2139/ssrn.2437916

Cited by 36 publications

(22 citation statements)

References 5 publications

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“…This may be the case, for example, if high or volatile margin requirements impose externalities on markets for the collateral assets (Murphy, Vasios and Vause (2014)), or if agency problems mean that dealers take excessive risks. In such cases, a systemic risk regulator should have a higher degree of risk aversion than the dealer agents, and so may determine that the optimal policy measure is to mandate central clearing.…”

Section: Discussionmentioning

confidence: 99%

Does Central Clearing Reduce Counterparty Risk in Realistic Financial Networks?

Garratt

Zimmerman

2015

SSRN Journal

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractNovating a single asset class to a central counterparty (CCP) in an over-the-counter derivatives trading network impacts both the mean and variance of total net exposures between counterparties. When a small number of dealers trade in a relatively large number of asset classes, central clearing increases the mean and variance of net exposures, which may lead to increased counterparty risk and higher margin needs. There are intermediate cases where there is a tradeoff: The introduction of a CCP leads to an increase in expected net exposures but this increase is accompanied by a reduction in variance. We extend the work of Duffie and Zhu (2011) by considering general classes of network structures and focus on scale-free and core-periphery structures, which have been shown to be accurate models of real-world financial networks. We find that a CCP is unlikely to be beneficial when the link structure of the network relies on just a few key nodes. In particular, in large scale-free networks a CCP will always worsen expected netting efficiency. In such cases, CCPs can improve netting efficiency only if agents have some degree of risk aversion that allows them to trade off the reduced variance against the higher expected netted exposures. This may explain why, in the absence of regulation, traders in a derivatives network may not develop a CCP themselves.

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Section: Discussionmentioning

confidence: 99%

Does Central Clearing Reduce Counterparty Risk in Realistic Financial Networks?

Garratt

Zimmerman

2015

SSRN Journal

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“…Let us assume that the dealers are less averse to volatility and the associated extreme outcomes than is socially optimal. This may be the case, for example, if high or volatile margin requirements impose externalities on markets for the collateral assets (Murphy, Vasios, and Vause (2014)), or if agency problems mean that dealers take excessive risks. In such cases, the dealers would not wish to introduce centralized netting, even though it may be socially optimal to do so.…”

Section: Generalization To Several Ccps and Multiple Asset Classesmentioning

confidence: 99%

Centralized netting in financial networks

Garratt

Zimmerman

2020

Journal of Banking & Finance

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We consider how the introduction of centralized netting in financial networks affects total netted exposures between counterparties. In some cases there is a trade-off: centralized netting increases the expectation of net exposures, but reduces the variance. We show that the set of networks for which expected net exposures decreases is a strict subset of those for which the variance decreases, so the trade-off can only be in one direction. For some network structures, introducing centralized netting is never beneficial to dealers unless sufficient weight is placed on reductions in variance.This may explain why, in the absence of regulation, traders in a derivatives network do not develop central clearing. Our results can be used to estimate margin requirements and counterparty risk in financial networks.

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“…Like VM, IM generally increases during times of financial-market volatility. As discussed in Murphy et al (2014), the requirements to cover a quantile of market moves requires IM models to be risk-sensitive, and therefore procyclical, to at least some degree. However, while the pass-through of volatility to VM is largely mechanical and out of the CCP's control, the factors determining IM are more complex and depend on the specific practices the CCP follows.…”

Section: Potential Procyclical Resource Demandmentioning

confidence: 99%

“…A key component of CCP risk management is margin: cash and collateral posted to the CCP to cover current and potential future exposures of clearing members and their clients. The procyclicality of margin requirements has been studied by Murphy et al (2014) and Glasserman 3 The FSB (2017a, 2018a) has detailed the high interconnectedness between the largest CCPs and eleven to twenty large financial institutions. and Wu (2018), and regulatory bodies have highlighted this procyclicality as a concern (e.g.…”

Section: Introductionmentioning

confidence: 99%

Central Clearing and Systemic Liquidity Risk

King¹,

Nesmith

Paulson

et al. 2020

FEDS

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By stepping between bilateral counterparties, a central counterparty (CCP) transforms credit exposure. CCPs generally improve financial stability. Nevertheless, largeCCPs are by nature concentrated and interconnected with major global banks. Moreover, although they mitigate credit risk, CCPs create liquidity risks, because they rely on participants to provide cash. Such requirements increase with both market volatility and default; consequently, CCP liquidity needs are inherently procyclical. This procyclicality makes it more challenging to assess CCP resilience in the rare event that one or more large financial institutions default. Liquidity-focused macroprudential stress tests could help to assess and manage this systemic liquidity risk.

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An Investigation into the Procyclicality of Risk-Based Initial Margin Models

Cited by 36 publications

References 5 publications

Does Central Clearing Reduce Counterparty Risk in Realistic Financial Networks?

Does Central Clearing Reduce Counterparty Risk in Realistic Financial Networks?

Centralized netting in financial networks

Central Clearing and Systemic Liquidity Risk

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