Emulating the Standard Initial Margin Model: initial margin forecasting with a stochastic cross-currency basis

Christoph M. Puetter and Stefano Renzitti

Journal of Credit Risk

Abstract: A common shortcut for forecasting initial margin requirements and margin valuation adjustments that are aligned with the International Swaps and Derivatives Association’s Standard Initial Margin Model relies on simulating and recalibrating value-at-risk quantiles. Doing so largely avoids costly sensitivity calculations but works only if the relevant risks are appropriately represented in the simulation model. In this paper we highlight the impact of missing cross-currency basis risk factors on estimating initial margin and margin valuation adjustments for instruments with a cross-currency basis sensitivity. We propose a parsimonious, consistent and efficient stochastic cross-currency basis model extension as remedy and provide illustrative examples. The examples cover vanilla interest rate swaps and resetting and non-resetting cross-currency basis swaps in Canadian dollars, euros, Japanese yen and US dollars. In addition to initial margin and margin valuation adjustment, we also compute and compare the impact on residual credit valuation adjustment.

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