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Financial Stability and Regulatory Compliance

Optimality Criteria for Commodity Futures Margin Requirements

Margin requirement is one of the most prolifically debated risk management methods for clearing houses. There are two main schools of thought for setting margin requirements: the prudential approach of Figlewski (1984) and Gay et al. (1986) which argues that the main purpose of margins is to cover the clearing house’s loss when participants default; and the efficient contract design of Brennan (1986), which examines how margins and price limits can be set to make the contracts self-enforcing.

These pioneering works have lead extant literature to conclude that the optimal margin level should be: 1. high enough to cover the default risk faced by the clearing house when taking on defaulters’ positions; 2. low enough to limit investors’ opportunity costs and maintain liquidity in the market; and 3. stable enough to reduce investors’ additional opportunity costs when margin changes. However, the stable-margin problem is poorly addressed in the academic literature. To address this, this study develops a model for a margin level that is stable yet also an accurate reflection of the dynamic market volatility. An optimal balance of such criteria is ensured by calibrating the model in-sample and then employing fuzzy goal programming to allow for stability out-of-sample.

University: University of Sussex
Project Lead: Carol Alexander

Lead Researcher

Carol Alexander

Carol Alexander is a Professor of Finance at the University of Sussex and Managing Editor of the Journal of Banking and Finance, with Geert Bekaert. She holds degrees from the University of Sussex (BSc First Class, Mathematics with Experimental Psychology; PhD Algebraic Number Theory) and the London School of Economics (MSc Econometrics and Mathematical Economics). She has an Honorary Professorship at the Academy of Economic Studies in Bucharest, Romania.

Carol has held the following positions in financial institutions: Fixed Income Trader at UBS/Phillips and Drew (UK); Academic Director of Algorithmics (Canada); Director of Nikko Global Holdings and Head of Market Risk Modeling (UK); Risk Research Advisor, SAS (USA). She also acts as an expert witness and consultant in financial modelling.