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An Empirical Analysis of Futures Margin Changes: Determinants and Policy Implications

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Abstract

Margin regulation raises two policy concerns. First, an alignment of margins to volatility can amplify procyclicality, leading to a build-up of excess leverage in good times and a forced deleverage in bad times. Second, competition among central counterparties (CCPs) can result in lower margin levels in order to attract more trading volume, which is referred to as a “race to the bottom.” Motivated by these issues, we empirically analyze the determinants of margin changes by using a data set of various futures margins from Chicago Mercantile Exchange (CME) Group. We first find that CME Group raises margins quickly following volatility spikes but does not immediately lower margins following volatility declines, implying that margin-induced procyclicality is more of a concern in recessions than in expansions. In addition, we find some evidence that the margin difference between CME Group and its competitor, Intercontinental Exchange (ICE), is an important driver of margin changes after changes in other margin determinants are controlled for, implying that competition may be factored into margin setting.

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Notes

  1. This reform was initially decided on by the Group of Twenty (G20) in September 2009, and once it takes effect, about 46 percent of the current notional value of OTC derivatives is expected to be centrally cleared as reported in a quantitative impact study by BCBS and IOSCO (2013).

  2. The scope of supervision goes beyond the margin requirements, covering collateral requirements, default fund management, and the clearing and settlement procedures.

  3. CME Group provides clearing services through the in-house clearing division. Besides, it was formed when CME and CBOT (Chicago Board of Trade) merged in 2007, and it later acquired NYMEX (New York Mercantile Exchange) and COMEX (Commodity Exchange), in March 2008, and KCBOT (Kansas City Board of Trade), in December 2012.

  4. Santos and Scheinkman (2001) present a model of financial intermediation in which margin requirements can be used as a screening device when clearing members’ credit quality is private information, and show that there will be a “race to the bottom” if the exogenous bankruptcy penalty is low.

  5. For example, it is used in the RiskMetrics solution of J.P. Morgan.

  6. We test λ = 0.97, λ = 0.98, and λ = 0.99 and find that λ = 0.98 results in the highest statistical significance.

  7. See, for example, Brunetti and Lildholdt (2007).

  8. For example, ranges have been publicized for many decades in the financial press, often in the form of candlestick charts.

  9. See “Quick Facts on Margins at CME Clearing,” CME Group, July 2011.

  10. Historical margin data are available at http://www.cmegroup.com/clearing/risk-management/historical-margins.html.

  11. See http://archive.opnmkts.com/clearing/understanding-margin-changes.

  12. In practice, CME group sometimes sends out an advisory notice in more than two business days in advance.

  13. See “Quick Facts on Margins at CME Clearing,” CME Group, July 2011.

  14. Alternatively, one can assume that β 0 = 0, letting L and U both be free parameters.

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Authors and Affiliations

  1. Federal Reserve Board, Washington, USA

    Yang-Ho Park

  2. https://www.linkedin.com/in/abruzzonicole

    Nicole Abruzzo

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  1. Yang-Ho Park
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  2. Nicole Abruzzo
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Correspondence to Yang-Ho Park.

Additional information

We are grateful for comments and suggestions from Celso Brunetti, Sean Campbell, Sanjiv Das, Michael Gordy, Erik Heitfield, Jim O’Brien, Haluk Unal (editor) and seminar participants at the Federal Reserve Board; the Bank of Canada Conference on Collateral, Liquidity, and Central Bank Operation; and the European Central Bank, Banque de France, and Bank of England Conference on OTC Derivatives Reform. This paper benefited from the excellent research assistance of Juliette Lu, and was written while Nicole Abruzzo was at the Federal Reserve Board. Disclaimer: The analysis and conclusions set forth are those of the authors and do not indicate concurrence by the Board of Governors or other members of its research staff. Send correspondence to Yang-Ho Park, Risk Analysis Section, the Federal Reserve Board, 20th & C Streets, NW, Washington, D.C. 20551.

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Park, YH., Abruzzo, N. An Empirical Analysis of Futures Margin Changes: Determinants and Policy Implications. J Financ Serv Res 49, 65–100 (2016). https://doi.org/10.1007/s10693-014-0212-8

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