Optimal margin requirement

We investigate the optimal level of margin requirement in centralized or decentralized clearing and settlement systems. We prove in an analytical model that aggressively risk-sensitive margins are not optimal, and the actual position of the clients and the general macroeconomic conditions, like overall funding liquidity should also be taken into consideration. For example, in a crisis period characterized by high volatility, the clearing institution may be tempted to require larger margins to cover potential losses, however, clients just have difficulties to finance higher margins, hence, the probability of non-payment increases, and the expected loss of the clearing institution may also increase. We show that under realistic specifications, there exists a unique optimal margin minimizing the expected loss of the clearing institution. Characterizing this optimum, we provide a micro-level foundation for anti-cyclical risk management techniques (margins, collaterals, haircuts etc.) in general.