A Martingale Characterization of Consumption Choices and Hedging Costs with Margin Requirements

Hong, Liu; Cuoco, Domenico

doi:10.2139/ssrn.242878

Cited by 40 publications

(47 citation statements)

References 7 publications

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“…It is thus conceivable that margin requirements affect agents' trading behavior and market activity. Cuoco and Liu (2000) incorporate margin requirements into the portfolio optimization problem of a single agent and computed the effects on portfolio weights, albeit for the trading of primary assets. An adverse effect of margins on market liquidity is noted by Telser (1981).…”

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confidence: 99%

Margining in Derivatives Markets and the Stability of the Banking Sector

Gibson

Murawski

2011

SSRN Journal

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a b s t r a c tWe investigate the effects of margining, a widely-used mechanism for attaching collateral to derivatives contracts, on derivatives trading volume, default risk, and on the welfare in the banking sector. First, we develop a stylized banking sector equilibrium model to develop some basic intuition of the effects of margining. We find that a margin requirement can be privately and socially sub-optimal. Subsequently, we extend this model into a dynamic simulation model that captures some of the essential characteristics of over-the-counter derivatives markets. Contrarily to the common belief that margining always reduces default risk, we find that there exist situations in which margining increases default risk, reduces aggregate derivatives' trading volume, and has an ambiguous effect on welfare in the banking sector. The negative effects of margining are exacerbated during periods of market stress when margin rates are high and collateral is scarce. We also find that central counterparties only lift some of the inefficiencies caused by margining.

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confidence: 99%

Margining in Derivatives Markets and the Stability of the Banking Sector

Gibson

Murawski

2011

SSRN Journal

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“…Cuoco and Liu (2000) characterize the optimal consumption and portfolio choices for an investor that is subject to margin requirements and that does not receive income; i.e., Y ≡ 0. The case of an investor that receives an income stream and is subject to margin requirements is considerably more complicated than the case without income.…”

Section: Benchmark Case: No Margin Requirements Labor Income Spannedmentioning

confidence: 99%

“…Koo (1998) and Koo (1999) solve the optimal investment and consumption problem for an investor that receives labor income and faces a short-sale constraint and describes properties of the optimal consumption plan, but does not discuss underdiversification. Cuoco and Liu (2000) discuss the case of an investor that is facing margin requirements but does not receive income, and provide a characterization of his optimal investment strategy. He andPagès (1993), El Karoui andJeanblanc-Picqué (1998) and Duffie, Fleming, Soner, and Zariphopoulou (1997) study the optimal asset selection problem of an investor who receives income and who is constrained to maintain nonnegative levels of current wealth, but do not address margin requirements.…”

Section: Introductionmentioning

confidence: 99%

Why does junior put all his eggs in one basket? A potential rational explanation for holding concentrated portfolios

Roche

Tompaidis

Yang

2013

Journal of Financial Economics

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Empirical studies of household portfolios show that young households, with little financial wealth, hold underdiversified portfolios that are concentrated in a small number of assets, a fact often attributed to behavioral biases. We present a potential rational alternative: we show that investors with little financial wealth, who receive labor income, rationally limit the number of assets they invest in when faced with financial constraints such as margin requirements and restrictions on borrowing. We provide theoretical and numerical support for our results and identify the ratio of financial wealth to labor income as a useful control variable for household portfolio studies.JEL classification: D81, D83, E21, G11.

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“…Thus our model could be adapted to include discrete versions of Detemple and Murthy [10] and Cuoco and Liu [5] on trading restrictions.…”

Section: Extensions and Generalizations Of The Modelmentioning

confidence: 99%

Taxation and Transaction Costs in a General Equilibrium Asset Economy

Jin

Milne

2007

Applied and Numerical Harmonic Analysis

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Summary. Most financial asset pricing models assume frictionless, competitive markets that imply the absence of arbitrage opportunities. Given the absence of arbitrage opportunities and complete asset markets, there exists a unique martingale measure that implies martingale pricing formulae and replicating asset portfolios. In incomplete markets, or markets with transaction costs, these results must be modified to admit non-unique measures and the possibility of imperfectly replicating portfolios. Similar difficulties arise in markets with taxation. Some theoretical research has argued that some taxation functions will imply arbitrage opportunities and the non-existence of a competitive asset economy. In this paper we construct a multi-period, discrete time/state general equilibrium model of asset markets with transaction costs and taxes. The transaction cost technology and the tax system are quite general, so that we can include most discrete time/state models with transaction costs and taxation. We show that a competitive equilibrium exists. Our results require careful modeling of the government budget constraints to rule out tax arbitrage possibilities.

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A Martingale Characterization of Consumption Choices and Hedging Costs with Margin Requirements

Cited by 40 publications

References 7 publications

Margining in Derivatives Markets and the Stability of the Banking Sector

Margining in Derivatives Markets and the Stability of the Banking Sector

Why does junior put all his eggs in one basket? A potential rational explanation for holding concentrated portfolios

Taxation and Transaction Costs in a General Equilibrium Asset Economy

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