Volatility and Margining in Futures Exchange

• Main Authors: Lim, Kian Guan, Low, Teng Yong
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 1996
• Subjects: Business
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/2257; https://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=6914982&site=ehost-live
• Institution: Singapore Management University

The purpose of this article is to present an alternative method of computing volatility for the purpose of setting margins. The setting of margins is closely related to the volatility of futures price changes. If volatility for the forthcoming week is expected to be high, then margins should be set larger. If volatility is expected to be low, then margins may be smaller. Margins posted by trading members are costly to them, so excessively large margins are not desirable. On the other hand, inadequate margins would result in frequent intra-day margin calls, and even if the trading firms do not pose any risk of default, it may reflect unfavorably on the Exchange's margin management. Thus, the setting of margins is an important exercise. Using an alternative volatility prediction model might give estimates that are significantly closer to the true volatilities than using historical averages of price deviations. In the context of margin setting, the issue is whether margins based on such a model, as compared to margins based on historical averages, would give the Exchange more confidence in typical future price movements being contained within the maintenance margin.