Valuation of initial margin using bootstrap method

Abstract

Purpose

The purpose of this paper is to propose the parametric bootstrap method for valuation of over-the-counter derivative (OTCD) initial margin (IM) in the financial market with low outstanding notional amounts. That is, an aggregate outstanding gross notional amount of OTC derivative instruments not exceeding R20bn.

Design/methodology/approach

The OTCD market is assumed to have a Gaussian probability distribution with the mean and standard deviation parameters. The bootstrap value at risk model is applied as a risk measure that generates bootstrap initial margins (BIM).

Findings

The proposed parametric bootstrap method is in favour of the BIM amounts for the simulated and real data sets. These BIM amounts are reasonably exceeding the IM amounts whenever the significance level increases.

Research limitations/implications

This paper only assumed that the OTCD returns only come from a normal probability distribution.

Practical implications

The OTCD IM requirement in respect to transactions done by counterparties may affect the entire financial market participants under uncleared OTCD, while reducing systemic risk. Thus, reducing spillover effects by ensuring that collateral (IM) is available to offset losses caused by the default of a OTCDs counterparty.

Originality/value

This paper contributes to the literature by presenting a valuation of IM for the financial market with low outstanding notional amounts by using the parametric bootstrap method.

Citation

Seitshiro, M.B. and Mashele, H.P. (2020), "Valuation of initial margin using bootstrap method", Journal of Risk Finance, Vol. 21 No. 5, pp. 543-557. https://doi.org/10.1108/JRF-10-2019-0203