It has been widely believed that mandatory posting of initial margin (IM) required by the BCBS-IOSCO margin rules should effectively eliminate counterparty risk from bilateral trading. We apply our new framework for collateralized exposure modeling and show that this is not necessarily true, as the time lags between trade payments and the corresponding margin posting produce exposure spikes that can substantially exceed the VaR-based IM levels. Thus, while being effective in eliminating exposure between the spikes, the BCBS-IOSCO-mandated IM fails to suppress the spikes. We demonstrate that, in the presence of IM specified as 2-week 99% VaR, as much as 95% of CVA can be due to exposure spikes, while the overall relative reduction of CVA resulting from IM posting can be an order of magnitude smaller than what one would expect without accounting for trade payments (roughly, a factor of 10 instead of a factor of 100). We supplement our analysis with several practical schemes for improving the speed and stability of collateralized exposure simulation.
Joint work with: Leif ANDERSEN, Alexander SOKOL.