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Practice paper

Capturing initial margin in counterparty risk calculations

Lee Moran and Sascha Wilkens
Journal of Risk Management in Financial Institutions, 10 (2), 118-129 (2017)
https://doi.org/10.69554/FXIX9450

Abstract

This paper compares a range of alternative approaches to incorporate Initial Margins (IMs) in the modelling of counterparty credit risk exposures. IMs have risen in importance following the rise of Central Counterparties to clear OTC derivatives and the recent legislation requiring bilateral margining for uncleared derivatives between financial counterparties. IMs have become an essential model component that drives exposure, associated regulatory capital requirements and valuation adjustments such as Credit Valuation Adjustment (CVA) and Margin Valuation Adjustment (MVA). The influence of the modelling choices is explored by means of typical derivatives portfolios. For the actual estimation of a path-dependent (‘stochastic’) IM through time the use of quantile regression is suggested as an econometrically reliable approximation. Banks’ internal counterparty risk models will likely exhibit a basis vis-à-vis the actual IM mechanisms in practice (for example, owing to different risk factor representations and/or calibrations). In this context, the paper suggests that a simplified representation in the form of a ‘dynamic IM’ can approximate most of the quantities of interest to a reasonable degree.

Keywords: initial margin, clearing, bilateral margining, counterparty risk, internal model

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Author's Biography

Lee Moran is a senior quantitative analyst at BNP Paribas, Risk Analytics & Modelling in London. Focused in the risk and regulatory capital area, Lee has been involved in the development of internal models for market and counterparty risk since 1999 and has presented at numerous international conferences on these topics. Prior to joining BNP Paribas in 2003, Lee worked at other investment banks in similar fields. Lee has a physics degree from the University of Oxford.

Sascha Wilkens is a senior manager at BNP Paribas, Risk Analytics & Modelling in London and previously held other positions in banking and quantitative consulting. He has published more than 60 papers in finance, many of them in internationally renowned peer-reviewed journals. His research interests are currently focused on risk measurement and empirical capital market research. Sascha is a CFA and CAIA charterholder and holds a PhD in finance as well as a Master’s degree in applied mathematics.

Citation

Moran, Lee and Wilkens, Sascha (2017, April 1). Capturing initial margin in counterparty risk calculations. In the Journal of Risk Management in Financial Institutions, Volume 10, Issue 2. https://doi.org/10.69554/FXIX9450.

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cover image, Journal of Risk Management in Financial Institutions
Journal of Risk Management in Financial Institutions
Volume 10 / Issue 2
© Henry Stewart
Publications LLP

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