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Margining in derivatives markets and the stability of the banking sector

Rajna Gibson and Carsten Murawski

Journal of Banking & Finance, 2013, vol. 37, issue 4, 1119-1132

Abstract: We 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.

Keywords: Derivative securities; Default risk; Collateral; Margining; Systemic risk (search for similar items in EconPapers)
JEL-codes: G19 G21 (search for similar items in EconPapers)
Date: 2013
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Handle: RePEc:eee:jbfina:v:37:y:2013:i:4:p:1119-1132