Rethinking Margin Period of Risk
Leif B. G. Andersen (Bank of America Merrill Lynch)
Michael Pykhtin (Board of Governors of the Federal Reserve System)
Alexander Sokol (CompatibL)
In this paper, authors describe a new framework for collateralized exposure modelling under an ISDA Master Agreement with a Credit Support Annex. The proposed model captures legal and operational aspects of default in considerably greater detail than models currently used by most practitioners, while remaining fully tractable and computationally feasible. Specifically, it considers the remedies and suspension rights available within these legal agreements; the firm's policies in availing itself of these rights; and the typical time it takes to exercise them in practice. The inclusion of these effects is shown to produce significantly higher credit exposure for representative portfolios compared to the currently used models. The increase is especially pronounced when dynamic initial margin is also present.
Download the full paper from the Social Science Research Network (SSRN) eLibrary here.
The paper was presented by Alexander Sokol on the Quants Hub webinar on March 22, 2016.
Watch a free video of the webinar on Quants Hub.