Margining in derivatives markets and the stability of the banking sector

Abstract

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.

Agent-Principal Problem, Stewardship Theory and Behavioural Agency Model in the Explanation of Family Business Performance

“…The authors develop three optimistic margins hypotheses of credit derivatives which are based on the assumption that banks' objectives are to completely hedge their exposure to market risk, and they are to hedge themselves from interest rate risk. Gibson et al (2013) find that the margin from credit derivatives increase default risk, and have "an ambiguous effect on welfare in the banking sector". The authors believe the ways banks get the optimal margins are caused by default risk mechanism that they chose.…”

“…So, this study will discuss more depth the matter of Sakurai et al (2014) in the next section. Gibson et al (2013) investigates the effects of margining while banks use credit derivatives. The authors develop three optimistic margins hypotheses of credit derivatives which are based on the assumption that banks' objectives are to completely hedge their exposure to market risk, and they are to hedge themselves from interest rate risk.…”

“…The authors believe the ways banks get the optimal margins are caused by default risk mechanism that they chose. Whatever, the assumptions of Gibson et al (2013) are too strong and ignore the act of speculators. On the similar approach line as Gibson, Sakurai et al (2014) develops the "credit immigration" of collateral derivatives to fill the gap of this factor which belongs to off-balance-sheet leverage into derivatives activities study.…”

Central Clearing and Systemic Liquidity Risk

“…The increasing contingent obligations of 4 Duffie (2014) study how collateral demands shift with the introduction of mandatory margin and central clearing. Similarly, Heller and Vause (2012) show that the current set of rules can place significant liquidity burdens on clearing members, potentially contributing to their failure, and Gibson and Murawski (2013) study banks' trading behavior and welfare under different margin regimes. However, the analyses in these papers are static; they do not consider how liquidity demands vary over time with financial-market conditions.…”