Margin requirements based on a stochastic correlation model

Abstract

We demonstrate that margin requirements of central counterparties show a significantly different behavior when calculated with a portfoliowise treatment instead of taking the weighted sum of the margin requirements of the components without accounting for their correlation structures. This is shown via simulating trajectories of a joint stochastic volatility–stochastic correlation model. Results indicate that an unnecessarily large overmargin requirement is set by regulators when the applied risk measure is not calculated via a portfoliowise treatment. Finally, accounting for the correlation structure of the assets during the margining process would not lead to an overly prudent method, nor would it cause greater procyclicality.

The Effect of Anti‐Procyclical Central Counterparty Margins On Trading

“…In addition to the sensitivity of margin models, use of portfolio margining (as opposed to individual asset-wise margining ignoring inter-asset correlations) also affects procyclicality. Margin models that use portfolio margining are less procyclical in addition to being more efficient (Szabó and Váradi 2022). A key decision in CCP design is balancing the tradeoff between margins and default fund as layers of protection.…”