Credit Exposure in the Presence of Initial Margin

We leverage the new framework for collateralized exposure modelling in Andersen, Pykhtin, and Sokol (2016) to analyze credit risk on positions collateralized with both variation and initial margin. Special attention is paid to the dynamic BCBS-IOSCO uncleared margin rules soon to be mandated for bilateral inter-dealer trading in OTC derivatives markets. While these rules set initial margin at a 99th 2-week percentile level and aim to all but eliminate portfolio close-out risk, we demonstrate that trade flow effects can result in exposures being reduced significantly less than expected. We supplement our analysis with several practical schemes for estimating IM on a simulation path, and for improving the speed and stability of exposure simulation. We also briefly discuss potential ways to adjust the margin framework to more effectively deal with exposures arising from trade flow events