Counter-Cyclical Margin Calculation System for Option Portfolios

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We develop a counter-cyclical margin calculation system app for option portfolios aimed at mitigating procyclicality whilst making full use of possible hedge properties within a portfolio. We also aim to present the supremum of the possible loss in terms of both the underlying asset’s future price and the time to maturity, and thus explicitly show the extent of the worst-case scenario. With this app, the regulator can observe the difference between the current market-condition-dependent margin level and the worst-case scenario loss, and adjust the emphasis on counter-cyclicality by modifying the parameters in our margin system.

Our approach differs from the most popular margin calculation currently used, which applies simulation methodology. This calculates the portfolio value among a finite number of selected scenarios and defines the margin of the portfolio as the maximal loss among these scenarios. While this risk-based approach is easy to implement, it depends on subjective scenario settings and thus market conditions. The approach is inevitably procyclical: the margin requirement is low in good times and high in bad times. As a result, traders receive margin calls and have to post additional collateral, often just at the time when a turbulent market makes it difficult for traders to raise cash or other liquid assets. To stabilize the financial markets, the financial industry has raised its concern on the procyclicality of such margin models. This project aims to answer these concerns.

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