Forecasting initial margin requirements: A model evaluation
Abstract
The introduction of mandatory margining for non-cleared derivatives portfolios has major implications for the pricing and risk measurement of over-the-counter (OTC) derivatives. In particular, a model for estimating future initial margin requirements is necessary to enable the calculation of relevant pricing adjustments, net counterparty credit exposures and credit capital requirements. Existing literature on the topic suggests a model that makes use of regression techniques, but little detail is available on the predictive quality of these models within a Monte Carlo simulation framework. We review these regression-based initial margin models in detail and compare their output against the actual margin requirements measured by the International Swaps and Derivatives Association standard initial margin model (ISDA SIMM) methodology. We observe that the models generally perform well for single trades but show some degradation for larger diversified portfolios. We investigate potential extensions and improvements to the model, along with examining some additional ‘conservatism’ features that may have application in the context of credit exposure measurement. The initial margin modelling approaches discussed here are similarly applicable to centrally cleared or exchange-traded portfolios.
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Author's Biography
Peter Caspers is a senior quantitative analyst and developer at Quaternion Risk Management. He has been working for several financial institutions in different quantitative roles since 1999, is a regular contributor to and co-author of QuantLib, an open source library for quantitative finance, and co-authored the recent book ‘Interest Rate Derivatives Explained II’ (with Jorg Kienitz). He holds a degree in mathematics and computer science from the University of Dortmund.
Paul Giltinan is a principal consultant at Quaternion Risk Management. He has experience of designing, implementing and validating counterparty credit risk exposure models at numerous tier 1 banks. His main area of expertise is collateral margin models for derivatives portfolios. Prior to joining Quaternion he worked as a financial software consultant with Murex. Paul holds a BSc in applied mathematics and physics from University College Cork.
Roland Lichters has headed bank risk/IT departments, developing teams, processes, pricing, and risk methodologies and systems. As founding partner and CTO of Quaternion Risk Management, he focuses — besides his consulting and advisory work — on the firm’s pricing and risk analytics products. Roland holds a PhD in physics and lectures part time in financial engineering at Trinity College Dublin. He is co-author of the book ‘Modern Derivatives Pricing and Credit Exposure Analysis’.
Nikolai Nowaczyk is a consultant at Quaternion Risk Management, where he helps investment banks develop, implement and test quantitative models to assess risks. He is particularly interested in counterparty credit risk and has worked with clients on dynamic initial margin solutions. Nikolai holds a primary degree in mathematics from the University of Bonn, a PhD in mathematics from the University of Regensburg and has been an academic visitor at Imperial College London.
Citation
Caspers, Peter, Giltinan, Paul, Lichters, Roland and Nowaczyk, Nikolai (2017, October 1). Forecasting initial margin requirements: A model evaluation. In the Journal of Risk Management in Financial Institutions, Volume 10, Issue 4. https://doi.org/10.69554/OVZD8736.
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