Regulatory competition and the efficiency of alternative derivative product margining systems

Abstract

Although margin requirements would arise naturally in the context of unregulated trading of clearinghouse-guaranteed derivative contracts, the margin requirements on U.S. exchange-traded derivative products are subject to government regulatory oversight. At present, two alternative methodologies are used for margining exchangetraded derivative contracts. Customer positions in securities and securities options are margined using a strategy-based approach. Futures, futures-options, and securitiesoption clearinghouse margins are set using a portfolio margining system. This study evaluates the relative eciency of these alternative margining techniques using data on S&P500 futures-option contracts traded on the Chicago Mercantile Exchange. The results indicate that the portfolio margining approach i s a m uch more ecient system for collateralizing the one-day risk exposures of equity derivative portfolios. Given the overwhelming eciency advantage of the portfolio approach, the simultaneous existence of these alternative margining methods is somewhat puzzling. It is argued that the co-existence of these systems can in part be explained in the context of Kane's (1984) model of regulatory competition. The eciency comparison also provides insight into other industry and regulatory issues including the design of bilateral collateralization agreements and the eciency of alternative s c hemes that have been proposed for setting regulatory capital requirements for market risk in banks and other nancial institutions.

Margin Adequacy and Standards: An Analysis of the Crude Oil Futures Market

“…One of the most important functions in the day to day operation of a futures exchange is the determination of appropriate margin requirements. The current standard for setting margins in futures markets is the Statistical Portfolio Analysis of Risk (SPAN) system (see Kupiec and White (1995)), which uses simulation analysis of the impact of large intra-day changes in futures prices to estimate the margins necessary to protect the solvency of the futures exchange. The SPAN system unconditionally allows the impact of a wide range of prices and volatility levels to be examined.…”

Margin Requirements, Volatility, and Market Integrity: What Have We Learned since the Crash?

“…In the literature that relates margin requirements to the behavior of futures traders, most models follow T elser (1981) and assume that margin requirements im- 18 See Telser (1981) for an extensive discussion. 19 A partial list of references includes, Telser (1981), Tomek (1985), Figlewski (1984), Edwards (1983), Gay, Hunter, and Kolb (1986), Fishe and Goldberg (1986), Craine (1992), Fenn and Kupiec (1993), Moser (1993), Kupiec (1994), Kupiec and White (1996), and Day and Lewis (1997).…”

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