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Abstract

Details

Contingent Valuation: A Critical Assessment
Type: Book
ISBN: 978-1-84950-860-5

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Article
Publication date: 3 May 2016

William E. Balson and Gordon Rausser

Risk-based clearing has been proposed by Rausser et al. (2010) for over-the-counter (OTC) derivatives. This paper aims to illustrate the application of risk-based margins…

Abstract

Purpose

Risk-based clearing has been proposed by Rausser et al. (2010) for over-the-counter (OTC) derivatives. This paper aims to illustrate the application of risk-based margins to a case study of the mortgage-backed securities derivative portfolio of the American International Group (AIG) during the period 2005-2008. There exists sufficient publicly available information to examine AIG’s derivative portfolio and how that portfolio would depend on conjectural changes in margin requirements imposed on its OTC derivative positions. Generally, such data on OTC derivative portfolio positions are unavailable in the public domain, and thus, the AIG data provide a unique opportunity for an objective evaluation.

Design/methodology/approach

This paper uses modern financial methodology to evaluate risk-based margining and collateralization for the major OTC derivative portfolio of the AIG.

Findings

This analysis reveals that a risk-based margin procedure would have led to earlier margin calls of greater magnitude initially than the collateral calls actually faced by AIG Financial Products (AIGFP). The total margin ultimately required by the risk-based procedure, however, is similar in magnitude to the collateral calls faced by AIGFP by August 2008. It is likely that a risk-based clearing procedure applied to AIG’s OTC contracts would have led to the AIG undertaking significant hedging and liquidation of their OTC positions well before the losses built up to the point they had, perhaps avoiding the federal government’s orchestrated restructuring that occurred in September 2008.

Originality/value

There has been no published risk-based evaluations of a major OTC portfolio of derivatives for any company, let alone the AIG.

Details

Journal of Financial Economic Policy, vol. 8 no. 2
Type: Research Article
ISSN: 1757-6385

Keywords

To view the access options for this content please click here

Abstract

Details

Contingent Valuation: A Critical Assessment
Type: Book
ISBN: 978-1-84950-860-5

To view the access options for this content please click here
Article
Publication date: 9 November 2010

Gordon Rausser, William Balson and Reid Stevens

Systemic risk propagated through over‐the‐counter (OTC) derivatives can best be managed by a public‐private central counterparty clearing house. The purpose of this paper…

Abstract

Purpose

Systemic risk propagated through over‐the‐counter (OTC) derivatives can best be managed by a public‐private central counterparty clearing house. The purpose of this paper is to outline the market microstructure necessary for such a clearing house.

Design/methodology/approach

The paper proposes using an request for quote platform with an active permissioning system that uses analytic approximations based on Monte Carlo simulation to estimate default risk and a two‐part pricing scheme to efficiently price that risk.

Findings

It is found that comprehensive clearing for complex and standardized derivatives is feasible using the clearing framework.

Research limitations/implications

This research is limited by the authors' ability to give empirical examples. The paper gives a short example with data, but given the constraints on length, cannot go into more detail.

Practical implications

This comprehensive clearing structure, in contrast to current proposed government regulations, will not drive out the “good” with the “bad” OTC derivative instruments.

Originality/value

This is the only paper the authors are aware of that outlines a detailed framework for clearing all OTC derivatives.

Details

Journal of Financial Economic Policy, vol. 2 no. 4
Type: Research Article
ISSN: 1757-6385

Keywords

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