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Optimal margin level in futures markets: Extreme price movements

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  • François M. Longin

Abstract

Along with price limits and capital requirements, the margin mechanism ensures the integrity of futures markets. Margin committees and brokers in futures markets face a trade‐off when setting the margin level. A high level protects brokers against insolvent customers and thus reinforces market integrity, but it also increases the cost supported by investors and in the end makes the market less attractive. This article develops a new method for setting the margin level in futures markets. It is based on “extreme value theory,” which gives interesting results on the distribution of extreme values of a random process. This extreme value distribution is used to compute the margin level for a given probability value of margin violation desired by margin committees or brokers. Extreme movements are central to the margin‐setting problem, because only a large price variation may cause brokers to incur losses. An empirical study using prices of silver futures contracts traded on COMEX is also presented. The comparison of the extreme value method with a method based on normality shows that using normality leads to dramatic underestimates of the margin level. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 127–152, 1999

Suggested Citation

  • François M. Longin, 1999. "Optimal margin level in futures markets: Extreme price movements," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 19(2), pages 127-152, April.
    • Handle: RePEc:wly:jfutmk:v:19:y:1999:i:2:p:127-152
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    Cited by:

    1. Russell Barker & Andrew Dickinson & Alex Lipton & Rajeev Virmani, 2016. "Systemic Risks in CCP Networks," Papers 1604.00254, arXiv.org.
    2. Alexander, Carol & Deng, Jun & Zou, Bin, 2023. "Hedging with automatic liquidation and leverage selection on bitcoin futures," European Journal of Operational Research, Elsevier, vol. 306(1), pages 478-493.
    3. Arie Harel & Giora Harpaz & Joseph Yagil, 2005. "Forecasting futures returns in the presence of price limits," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 25(2), pages 199-210, February.
    4. Chen-Yu Chen & Jian-Hsin Chou & Hung-Gay Fung & Yiuman Tse, 2017. "Setting the futures margin with price limits: the case for single-stock futures," Review of Quantitative Finance and Accounting, Springer, vol. 48(1), pages 219-237, January.
    5. Yu-Ying Tzeng & Paul M. Beaumont & Giray Ökten, 2018. "Time Series Simulation with Randomized Quasi-Monte Carlo Methods: An Application to Value at Risk and Expected Shortfall," Computational Economics, Springer;Society for Computational Economics, vol. 52(1), pages 55-77, June.
    6. Alexander, Carol & Kaeck, Andreas & Sumawong, Anannit, 2019. "A parsimonious parametric model for generating margin requirements for futures," European Journal of Operational Research, Elsevier, vol. 273(1), pages 31-43.
    7. Vigne, Samuel A. & Lucey, Brian M. & O’Connor, Fergal A. & Yarovaya, Larisa, 2017. "The financial economics of white precious metals — A survey," International Review of Financial Analysis, Elsevier, vol. 52(C), pages 292-308.
    8. Raj Aggarwal & Min Qi, 2009. "Distribution of extreme changes in Asian currencies: tail index estimates and value-at-risk calculations," Applied Financial Economics, Taylor & Francis Journals, vol. 19(13), pages 1083-1102.
    9. Chen, Yan & Yu, Wenqiang, 2020. "Setting the margins of Hang Seng Index Futures on different positions using an APARCH-GPD Model based on extreme value theory," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 544(C).
    10. Hamed Tabasi & Vahidreza Yousefi & Jolanta Tamošaitienė & Foroogh Ghasemi, 2019. "Estimating Conditional Value at Risk in the Tehran Stock Exchange Based on the Extreme Value Theory Using GARCH Models," Administrative Sciences, MDPI, vol. 9(2), pages 1-17, May.
    11. Gong Xue & Songsak Sriboonchitta, 2013. "The optimal margin setting: The application of bivariate EVT method," The Empirical Econometrics and Quantitative Economics Letters, Faculty of Economics, Chiang Mai University, vol. 2(3), pages 56-74, September.
    12. Shi, Wei & Irwin, Scott H., 2006. "What Happens when Peter can't Pay Paul: Risk Management at Futures Exchange Clearinghouses," 2006 Annual meeting, July 23-26, Long Beach, CA 21087, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    13. John Galbraith & Serguei Zernov, 2009. "Extreme dependence in the NASDAQ and S&P 500 composite indexes," Applied Financial Economics, Taylor & Francis Journals, vol. 19(13), pages 1019-1028.

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