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Regulatory competition and the efficiency of alternative derivative product margining systems

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  • Paul H. Kupiec
  • A. Patricia White

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 exchange-traded derivative contracts. Customer positions in securities and securities options are margined using a strategy-based approach. Futures, futures-options, and securities-option clearinghouse margins are set using a portfolio margining system. This study evaluates the relative efficiency 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 is a much more efficient system for collateralizing the one-day risk exposures of equity derivative portfolios. Given the overwhelming efficiency 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 efficiency comparison also provides insight into other industry and regulatory issues including the design of bilateral collateralization agreements and the efficiency of alternative schemes that have been proposed for setting regulatory capital requirements for market risk in banks and other financial institutions

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File URL: http://www.federalreserve.gov/pubs/feds/1996/199611/199611abs.html
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File URL: http://www.federalreserve.gov/pubs/feds/1996/199611/199611pap.pdf
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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 96-11.

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Date of creation: 1996
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Handle: RePEc:fip:fedgfe:96-11

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Related research

Keywords: Derivative securities;

References

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  1. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
  2. Dimson, Elroy & Marsh, Paul, 1995. " Capital Requirements for Securities Firms," Journal of Finance, American Finance Association, vol. 50(3), pages 821-51, July.
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Cited by:
  1. Cotter, John, 2001. "Margin exceedences for European stock index futures using extreme value theory," Journal of Banking & Finance, Elsevier, vol. 25(8), pages 1475-1502, August.
  2. Elder, Adam & Gannon, Gerard, 1998. "Evaluation of volatility forecasts in an economic value framework," International Review of Financial Analysis, Elsevier, vol. 7(3), pages 221-236.
  3. Paul H. Kupiec, 1997. "Margin requirements, volatility, and market integrity: what have we learned since the crash?," Finance and Economics Discussion Series 1997-22, Board of Governors of the Federal Reserve System (U.S.).
  4. Luis Garicano & Rosa Lastra, 2010. "Towards a New Architecture for Financial Stability: Seven Principles," CEP Discussion Papers dp0990, Centre for Economic Performance, LSE.
  5. 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).
  6. Hentschel, Ludger & Smith, Clifford Jr., 1997. "Derivatives regulation: Implications for central banks," Journal of Monetary Economics, Elsevier, vol. 40(2), pages 305-346, October.

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