U.S. patent application number 12/879741 was filed with the patent office on 2011-02-24 for method and system for determining margin requirements.
This patent application is currently assigned to NEW YORK MERCANTILE EXCHANGE. Invention is credited to Robert A. Biolsi, Benjamin M. Chesir, Robert A. Levin.
Application Number | 20110047096 12/879741 |
Document ID | / |
Family ID | 40137534 |
Filed Date | 2011-02-24 |
United States Patent
Application |
20110047096 |
Kind Code |
A1 |
Levin; Robert A. ; et
al. |
February 24, 2011 |
METHOD AND SYSTEM FOR DETERMINING MARGIN REQUIREMENTS
Abstract
The present invention provides for a system and method of
applying value-at-risk determination of a financial portfolio to a
performance bond requirement and comparing the value-at-risk
determination with a traditional scenario-based performance bond
requirement.
Inventors: |
Levin; Robert A.; (Short
Hills, NJ) ; Chesir; Benjamin M.; (Woodmere, NY)
; Biolsi; Robert A.; (Bronx, NY) |
Correspondence
Address: |
BANNER & WITCOFF, LTD.,;ATTORNEYS FOR CLIENT NO. 006119
10 SOUTH WACKER DRIVE, SUITE 3000
CHICAGO
IL
60606
US
|
Assignee: |
NEW YORK MERCANTILE
EXCHANGE
New York
NY
|
Family ID: |
40137534 |
Appl. No.: |
12/879741 |
Filed: |
September 10, 2010 |
Related U.S. Patent Documents
|
|
|
|
|
|
Application
Number |
Filing Date |
Patent Number |
|
|
11766667 |
Jun 21, 2007 |
7813988 |
|
|
12879741 |
|
|
|
|
Current U.S.
Class: |
705/36R |
Current CPC
Class: |
G06Q 40/06 20130101;
G06Q 40/04 20130101; G06Q 40/00 20130101 |
Class at
Publication: |
705/36.R |
International
Class: |
G06Q 40/00 20060101
G06Q040/00 |
Claims
1. A method comprising: processing a position file indicating open
market positions associated with a trading portfolio; processing a
value-at-risk variant file; and computing, by a processor, a
value-at-risk-based margin requirement based on the position file
and the value-at-risk variant file.
2. The method of claim 1, further comprising computing a
scenario-based margin requirement based on the position file and a
scenario-based parameter file.
3. The method of claim 2, further comprising comparing the
value-at-risk-based margin requirement with the scenario-based
margin requirement to compute a revised margin requirement.
4. The method of claim 2, further comprising applying a credit or
debit to an account associated with the trading portfolio based on
a difference between the value-at-risk-based margin requirement and
the scenario-based margin.
5. The method of claim 2, further comprising applying a credit or
debit to the scenario-based margin requirement based on a
difference between the value-at-risk-based margin requirement and
the scenario-based margin requirement.
6. The method of claim 2, further comprising initiating a loan
based on a difference between the value-at-risk-based margin
requirement and the scenario-based margin requirement.
7. The method of claim 1, further comprising categorizing and
storing value-at-risk parameters in a value-at-risk database.
8. A computer readable medium storing computer executable
instructions that, when executed, cause an apparatus at least to
perform: processing a position file indicating open market
positions associated with a trading portfolio; processing a
value-at-risk variant file; and computing a value-at-risk-based
margin requirement based on the position file and the value-at-risk
variant file.
9. The computer readable medium of claim 8, wherein the computer
executable instructions, when executed, causes the apparatus to
compute a scenario-based margin requirement based on the position
file and a scenario-based parameter file.
10. The computer readable medium of claim 9, wherein the computer
executable instructions, when executed, causes the apparatus to
compute a revised margin requirement based on a comparison of the
value-at-risk-based margin requirement with the scenario-based
margin requirement.
11. The computer readable medium of claim 9, wherein the computer
executable instructions, when executed, causes the apparatus to
apply a credit or debit to an account associated with the trading
portfolio based on a difference between the value-at-risk-based
margin requirement and the scenario-based margin requirement.
12. The computer readable medium of claim 9, wherein the computer
executable instructions, when executed, causes the apparatus to
apply a credit or debit to the scenario-based margin requirement
based on a difference between the value-at-risk-based margin
requirement and the scenario-based margin requirement.
13. The computer readable medium of claim 9, wherein the computer
executable instructions, when executed, causes the apparatus to
initiate a loan based on a difference between the
value-at-risk-based margin requirement and the scenario-based
margin requirement.
14. The computer readable medium of claim 8, wherein the computer
executable instructions, when executed, causes the apparatus to
categorize and store value-at-risk parameters in a value-at-risk
database.
15. An apparatus comprising: a processor; and a memory storing
computer executable instructions that, when executed by the
processor, causes the apparatus at least to perform: processing a
position file indicating open market positions associated with a
trading portfolio; processing a value-at-risk variant file; and
computing a value-at-risk-based margin requirement based on the
position file and the value-at-risk variant file.
16. The apparatus of claim 15, wherein the computer executable
instructions, when executed by the processor, causes the apparatus
to compute a scenario-based margin requirement based on the
position file and a scenario-based parameter file.
17. The apparatus of claim 16, wherein the computer executable
instructions, when executed by the processor, causes the apparatus
to compute a revised margin requirement based on a comparison of
the value-at-risk-based margin requirement with the scenario-based
margin requirement.
18. The apparatus of claim 16, wherein the computer executable
instructions, when executed by the processor, causes the apparatus
to apply a credit or debit to an account associated with the
trading portfolio based on a difference between the
value-at-risk-based margin requirement and the scenario-based
margin requirement.
19. The apparatus of claim 16, wherein the computer executable
instructions, when executed by the processor, causes the apparatus
to apply a credit or debit to the scenario-based margin requirement
based on a difference between the value-at-risk-based margin
requirement and the scenario-based margin requirement.
20. The apparatus of claim 15, wherein the computer executable
instructions, when executed by the processor, causes the apparatus
to categorize and store value-at-risk parameters in a value-at-risk
database.
Description
REFERENCE TO RELATED APPLICATIONS
[0001] This application is a divisional application of U.S. patent
application Ser. No. 11/766,667 filed Jun. 21, 2007, the content of
which is expressly incorporated herein by reference in its
entirety.
TECHNICAL FIELD
[0002] The present invention generally relates to a system and
method for applying financial risk data to financial instruments.
More particularly, the present invention relates to a system and
method for applying the value-at-risk determination of a financial
portfolio to a performance bond requirement.
BACKGROUND
[0003] Most futures commodity exchanges calculate performance bonds
using a scenario based system such as the system developed by the
Chicago Mercantile Exchange called Standard Portfolio Analysis of
Risk.TM. (SPAN.RTM.). Since its implementation, SPAN has become the
industry standard for establishing performance bond or margin
requirements associated with a futures portfolio. As such, there
has been little in development of value-at-risk determinations for
performance bonds. As futures exchanges expand their product
offerings to more complex and exotic products, such as for example,
basis, calendar spread options, and average price options, the
limitations of the SPAN system for margin requirements become more
apparent.
[0004] Additionally, the tiered structure SPAN uses to apply
credits may misrepresent risk. For example, if a customer has long
and short outright futures positions intended to completely offset
his short and long calendar swaps, SPAN will spread the futures
first and the swaps second effectively producing two sets of
spreads with performance bond requirements on both. The trader
would expect the system to spread the long futures with the short
calendar swaps and vice versa which would otherwise produce
virtually no performance bond requirement. Moreover, the myriad of
potential spreads and offsets is difficult if not impossible to
cover while simultaneously margining in true risk terms with the
SPAN system because of certain rigidity in the SPAN software that
was initially developed for more traditional futures and options
trading.
[0005] Accordingly there is a need in the art for an alternative
performance bond or margining system that more accurately
determines an exchange customer's risk exposure by accounting for
all open positions in a portfolio, which accommodates the
increasing number of exotic products traded on the exchange, and
better allows for intra and inter commodity, calendar, and exchange
positions.
[0006] The discussion of the background to the invention herein is
included to explain the context of the invention. This is not to be
taken as an admission that any of the material referred to was
published, known, or part of the common general knowledge as at the
priority date of any of the claims.
[0007] Throughout the description and claims of the specification
the word "comprise" and variations thereof, such as "comprising"
and "comprises", is not intended to exclude other additives,
components, integers or steps.
SUMMARY
[0008] The present invention addresses a new method and system of
establishing and assessing margin requirements. More specifically,
the present invention provides an improved performance bond
requirement or margining system that more accurately accounts for a
portfolio's associated risk and overcomes the deficiencies of the
SPAN-based system.
[0009] The present invention includes a method for accurately
determining the risk associated with a portfolio using
value-at-risk ("value-at-risk" or "VAR") methodologies and then
using the VAR determination to establish a performance bond.
[0010] The present invention additionally includes a system and
method for comparing the computed VAR-based margin requirement with
the traditional SPAN-based margin requirement associated with a
particular portfolio or a subset of a particular portfolio, and
communicating the comparison of the two margin requirements with an
exchange clearing member.
[0011] The present invention further includes a method and system
for crediting or debiting a margin account with the difference
between the VAR-based margin requirement and the traditional
SPAN-based margin requirement.
[0012] An implementation of the present invention is directed to a
method of determining margin requirements for a portfolio of
positions on products traded on an exchange, the method comprising:
identifying at least one open market position within the portfolio
of all contracts within the portfolio that are cleared by or on
behalf of the exchange; utilizing a VAR protocol to determine a
clearing member's risk exposure associated with the at least one
identified open market position; computing the a margin requirement
for said the clearing member; and notifying the clearing member of
the computed margin requirement.
[0013] An implementation of the present invention is further
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, the
method further comprising: receiving a request from a clearing
member to determine a margin requirement based on VAR protocols for
a portfolio of positions on products traded on an exchange, the
portfolio associated with the clearing member.
[0014] An implementation of the present invention is still further
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, the
method further comprising receiving a request on behalf of a
customer of the clearing member.
[0015] Another implementation of the present invention is directed
to a method of determining margin requirements for a portfolio of
positions on products traded on an exchange, the method further
comprising: assessing the margin requirement to the clearing member
in the form of a credit or debit.
[0016] An additional implementation of the present invention is
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, the
method further comprising: identifying all open market positions
associated with a portfolio.
[0017] A further implementation of the present invention is
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, wherein
at least one open market position comprises at least one
off-setting market positions.
[0018] Yet another implementation of the present invention is
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, utilizing
a VAR protocol based on a parametric model.
[0019] An additional implementation of the present invention is
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, utilizing
a VAR protocol based on a Monte Carlo simulation.
[0020] A further implementation of the present invention is
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, utilizing
a VAR protocol based on a historical simulation.
[0021] And another implementation of the present invention is
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, wherein
the margin requirement accounts for off-setting market
positions.
[0022] An additional implementation of the present invention is
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, wherein a
debit or credit is applied to a margin account associated with the
clearing member.
[0023] Another implementation of the present invention is directed
to a method of determining margin requirements for a portfolio of
positions on products traded on an exchange, wherein a debit or
credit is applied to a SPAN-based margin requirement.
[0024] A further implementation of the present invention is
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, the
method comprising: calculating a SPAN-based margin requirement;
comparing the SPAN-based margin requirement with a margin
requirement computed from a risk exposure determined utilizing VAR
protocols; obtaining a margin requirement variance; and notifying
the clearing member of the margin requirement variance.
[0025] Still another implementation of the present invention is
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, the
method further comprising adjusting a SPAN-based margin requirement
by a margin requirement variance.
[0026] An additional implementation of the present invention is
directed to a method of determining margin requirements for a
portfolio of positions on products traded on an exchange, the
method further comprising: calculating a SPAN-based margin
requirement wherein the risk exposure determined utilizing VAR
protocols is a parameter to the SPAN-based margin requirement
calculation.
[0027] A further implementation of the present invention is
directed to a system for generating a VAR-based performance bond
requirement, comprising: a selected position file indicating the
open market positions associated with a selected trading portfolio;
a VAR parameter generator operative to compute VAR variant files;
and a VAR calculation module operative to receive the selected
position file and the VAR variant files, to compute a VAR-based
margin requirement, and generate a VAR-based margin report;
[0028] An additional implementation of the present invention is
directed to a system for generating a VAR-based performance bond
requirement, comprising a SPAN calculation module operative to
receive a selected position file and a SPAN parameter file, to
compute a SPAN-based margin requirement, and generate a SPAN-based
margin report.
[0029] A further implementation of the present invention is
directed to a system for generating a VAR-based performance bond
requirement, comprising a comparison module being coupled with a
VAR calculation module and a SPAN calculation module so as to
access a VAR-based margin requirement and a SPAN-based margin
requirement, and being operative to compare the VAR-based margin
requirement with the SPAN-based margin requirement to compute a
revised margin requirement.
[0030] Still a further implementation of the present invention is
directed to a system for generating a VAR-based performance bond
requirement, comprising a report processor operative to apply the
difference between a VAR-based margin requirement and a SPAN-based
margin requirement to an account associated with a selected
portfolio in the form of a credit or debit.
[0031] Another implementation of the present invention is directed
to a system for generating a VAR-based performance bond
requirement, comprising a report processor operative to apply the
difference between a VAR-based margin requirement and a SPAN-based
margin requirement to a SPAN-based margin requirement in the form
of a credit or debit.
[0032] And yet another implementation of the present invention is
directed to a system for generating a VAR-based performance bond
requirement, comprising a VAR parameter archiver being coupled to a
VAR parameter generator and a VAR database, being further operative
to categorize VAR parameters received from the VAR parameter
generator and storing the VAR parameters in a VAR database.
[0033] As used herein, the term "SPAN based margin requirement,"
"SPAN based performance bond," and "SPAN based margin system"
refers to margin requirements or performance bonds, and systems for
calculating margin requirements or performance bonds, that utilize
a scenario based calculation, such as for example, the CME SPAN
system, or to performance bond systems that are based on or derived
from a scenario based performance bond system.
BRIEF DESCRIPTION OF THE DRAWINGS
[0034] FIG. 1 depicts a data flow diagram of a prior-art system for
determining the VAR measure of an existing trading portfolio.
[0035] FIG. 2 depicts a flow chart of a prior-art SPAM-based
margining system
[0036] FIG. 3 depicts a flow chart of an embodiment of a VAR-based
margining system, in accordance with the invention.
[0037] FIG. 4 depicts a flow chart of a system for VAR-based
margining in accordance with the invention.
DETAILED DESCRIPTION
[0038] Futures exchanges such as the New York Mercantile Exchange,
Inc. (NYMEX) provide a marketplace where futures, and options on
futures, are traded. Futures is a term used to designate all
contracts covering the purchase and sale of financial instruments
or physical commodities for future delivery on a commodity futures
exchange. A futures contract is a legally binding agreement to buy
or sell a commodity at a specified price at a predetermined future
time. Each futures contract is standardized and specifies
commodity, quality, quantity, delivery date and settlement. An
option is the right, but not the obligation, to sell or buy the
underlying instrument (in this case, a futures contract) at a
specified price within a specified time. In particular, a put
option is an option granting the right, but not the obligation, to
sell a futures contract at the stated price prior to the expiration
date. In contrast, a call option is an option contract which gives
the buyer the right, but not the obligation, to purchase a specific
futures contract at a fixed price (strike price) within a specified
period of time as designated by the Exchange in its contract
specifications. The buyer has the right to buy the commodity
(underlying futures contract) or enter a long position, i.e. a
position in which the trader has bought a futures contract that
does not offset a previously established short position. A call
writer (seller) has the obligation to sell the commodity (or enter
a short position, i.e. the opposite of a long position) at a fixed
price (strike price) during a certain fixed time when assigned to
do so by the clearing organization. The term "short" refers to one
who has sold a futures contract to establish a market position and
who has not yet closed out this position through an offsetting
procedure, i.e. the opposite of long. Generally, an offset refers
to taking a second futures or options on futures position opposite
to the initial or opening position, e.g. selling if one has bought,
or buying if one has sold.
[0039] A futures exchange clearing organization, sometimes referred
to as a clearing house, which may be a division of a futures
exchange or an independent company that works in conjunction with a
futures exchange, is responsible for settling trading accounts,
clearing trades, collecting and maintaining performance bond funds,
regulating delivery and reporting trading data. Clearing
organizations also serve as guarantors, ensuring that the
obligations of all trades are met, and thereby protecting buyers
and sellers from financial loss that otherwise could arise in
connection with potential default by a counterparty to any futures
trade or contract.
[0040] Clearing organizations are carefully structured to provide
futures exchanges with solid financial footing. A key component of
this structure are deposits made to a clearing organization to
ensure that traders meet the contractual obligations of the trades
they make. These deposits are known as performance bonds or margin
requirements.
[0041] Performance bonds or margin requirements are essentially
good-faith deposits which can be used to cover adverse movements in
futures prices. The futures exchange, acting through a clearing
organization, must ensure that participants have sufficient funds
to handle losses. In order to protect market participants and the
integrity of the market, futures exchanges establish margin
requirements at sufficiently high levels to adequately guard
against the risks associated with changing market conditions.
Futures exchanges establish specific margin requirements for the
exchanges institutional customers, known as clearing members, and
separate minimum margin requirements for customers of the clearing
members, which may be calculated, for example, at 110% greater for
member accounts and 135% greater for all other customers. As used
herein, the term "clearing member" refers to any entity associated
with a performance bond requirement, including, but not limited to
traditional clearing members authorized to hold over night their
own or their customers' positions on products traded, cleared or
settled on an exchange, clearing organizations or houses authorized
to clear positions on behalf of an exchange, or individual or
institutional entities or members of an exchange holding or trading
products on an exchange that are subject to a margin
requirement.
[0042] The amount required for a performance bond varies according
to the volatility of the product underlying the futures contract;
the more volatility, the larger the performance bond. This is to
ensure that the bond will cover maximum losses that a contract
would likely incur in a single day. Performance bonds may be
reduced where traders hold opposite positions in closely correlated
markets or spread trades. For example, a trader taking a sell
position, also known as a short position, in an S&P 500 product
while simultaneously taking a buy position, also know as a long
position, in a NASDAQ 100 product may qualify for a reduced spread
margin. Similarly, a trader taking a long position in November
Light Crude Oil and a short position in November Heating Oil may
also qualify for a reduced spread margin.
[0043] Traders who establish a position, either long, short or some
combination, need only maintain a certain amount of performance
bond or margin in their trading account. The margin required is a
percentage of the value of the contract, as determined each day,
and usually, but not always, ranges between 5% and 15%. The
percentage can range between 0% and 100%; 0% and 90%; 0% and 80%;
0% and 70%; 0% and 60%; 0% and 50%; 0% and 40%; 0% and 30%; 0% and
20%; or 0% and 10%. The percentage varies for each product
according to the product's price and volatility. Futures traders
don't exchange the full value of the underlying commodity--the
"notional value"--of any futures contract. They need only ensure
there is enough margin, or performance bond capital, in their
account as they monitor the daily price changes of each contract
they are trading. At the end of each day, and at some exchanges at
periodic intervals during the trading day, the futures exchange
identifies the current price for each contract or open position
held by a trader and then debits or credits each trader's account
according to that price.
[0044] Accounts that go under the amount of the deposit required
must immediately add money to bring the account back up to the
minimum, otherwise trading is not permitted on that account.
Accounts that are unable to meet the minimum may be closed by the
exchange.
[0045] Futures exchanges may require that the original margin on
all futures and certain options be deposited by its institutional
customers or clearing members on a gross basis for the clearing
member's long and short customers. Accordingly, the exchange may
then require that clearing members obtain initial margins from
their customers. In addition to initial margin deposits, daily
variation margin payments are made in cash to the exchange clearing
organization by clearing members who have sustained losses on their
futures positions. In turn, gains on futures positions are remitted
to the appropriate clearing member. For the clearing member's
customers, variation margin payments may be required by the
clearing member if an adverse price movement erodes margin on
deposit below the maintenance margin levels established by the
exchange clearing organization.
[0046] The margining systems presently used by futures exchanges to
calculate performance bond requirements are based on CME's SPAN
system. Margin requirements established by SPAN are based on the
overall risk of positions held by a clearing member in both the
clearing member's house and customer accounts. SPAN then determines
the overall risk of entire portfolios as calculated through options
pricing models. SPAN-based margining requirements treat futures and
options uniformly. The factors that affect option values in options
pricing models include futures price, volatility, and time to
expiration. As factors change, futures and options either gain or
lose value. SPAN uses these factors to calculate the worst possible
scenario and margins an entire portfolio on this basis. Futures
exchanges then require member firms to collect from their
customers' margins for open positions based on SPAN.
[0047] SPAN is a scenario analysis model that uses fixed software
(integrated in clearing member back office books and records
systems) and parameter files sent to all clearing members on a
nightly basis that update the scenarios and data that the software
uses. SPAN uses hard coded spread credits in the updates for inter
and intra commodity spreads to determine: (1) the overall delta or
risk exposure (aggregate position in a specific complex such as
Henry Hub Gas recognizing that there are several different
contracts that use Henry Hub Gas as its underlying commodity, such
as American and European options, futures, and swaps) and (2) the
credit or charge that is attributed to correlations or spreads such
as Heat to Gas, Crude to Heat, Calendar spreads etc. Within this
spread credit methodology SPAN also uses a tiered hierarchy to
determine which products get spread with which other product and in
which order to create credits or charges added to the risk in a
particular product sector.
[0048] The SPAN system, however, has certain deficiencies with
regard to intra- and inter-commodity spreads, inter-calendar
spreads, and inter-exchange spreads. These deficiencies do not
easily accommodate the increasing number of complex and relatively
exotic products offered on an exchange trading floor and the
associated electronic trading platform.
[0049] SPAN Process:
[0050] Futures exchanges establish minimum initial and maintenance
performance bond levels for products traded through the exchanges
facilities, including the trading floor and electronic trading
systems. These performance bond requirements are typically based on
historical price volatilities, current and anticipated market
conditions, and other relevant information. Performance bond levels
vary by product and are adjusted to reflect changes in price
volatility and other factors. Both initial and maintenance
performance bond levels represent the minimum amount of protection
against potential losses at which an exchange will allow a clearing
member to carry a position or portfolio. Should a clearing member's
customer's performance bonds on deposit with the clearing member
fall below the maintenance level, many exchanges require that the
account be pre-margined at the required higher initial performance
bond level. Clearing members may impose more stringent performance
bond requirements than the minimums set by the exchanges. At the
clearing organization level, clearing members must post at least
the maintenance performance bonds for all positions carried by the
clearing member, whether through the clearing members own
institutional account or through its many customer accounts.
[0051] In setting performance bond levels, the clearing
organization monitors current and historical price movements
covering short, intermediate and longer-term data using statistical
and parametric and non-parametric analysis. The clearing
organization, and often the exchanges' directors or other officers
typically set futures maintenance performance bond levels to cover
at least the maximum one-day price move on 95% of the days during
these time periods. The actual performance bond requirements often
exceed this level. Performance bond requirements for options
reflect movements in the underlying futures price, volatility, time
to expiration and other risk factors, and adjust automatically each
day to reflect the unique and changing risk characteristics of each
option series. In addition, long options must be paid for in full,
and exchanges typically require stringent minimum performance bonds
for short option positions.
[0052] Most futures commodity exchanges calculate performance bonds
with the SPAN system, which bases performance bond requirements on
the overall risk of the portfolios using parameters determined by
CME's Board of Governors. Prior to SPAN, performance bond
requirements were typically determined using either
"strategy-based" or "delta-based" systems. Delta methodology is
based on the measure of the price-change relationship between an
option and the underlying futures price and is equal to the change
in premium divided by the change in futures price.
[0053] SPAN simulates the effects of changing market conditions and
uses standard options pricing models to determine a portfolio's
overall risk. SPAN treats futures and options uniformly. In
standard options pricing models, three factors most strongly affect
options values: the underlying futures price, volatility
(variability of futures price) and time to expiration. As these
factors change, options may gain or lose value. SPAN constructs
scenarios of futures prices and volatility changes to simulate what
the entire portfolio might reasonably lose over a one day time
horizon. The resulting SPAN performance bond requirement covers
this potential loss.
[0054] SPAN evaluates overall portfolio risk by calculating the
worst probable loss that a portfolio might reasonably incur over a
specified time period. SPAN achieves this number by comparing
hypothetical gains and losses that a portfolio would sustain under
different market conditions. SPAN typically provides a "Risk Array"
analysis of 16 possible scenarios for a specific portfolio under
various conditions. Each scenario consists of a "what if" situation
in which SPAN assesses the effects of variations in price,
volatility and time to expiration. Each calculation represents a
gain or loss based on the possible gains or losses due to changes
in an instrument's price by X and volatility by Y.
[0055] SPAN licensed clearing organizations and exchanges
individually determine the following SPAN parameters, in order to
reflect the risk coverage desired in any particular market: price
scan range, volatility scan range, intra-commodity spread credit,
short option minimum, spot charge, and inter-commodity spread
credit. SPAN then combines financial instruments within the same
underlying group for analysis, and refers to this grouping as the
combined commodity group. For example, futures, options on futures
and options on equities on the same stock could all be grouped
under a single combined commodity.
[0056] To calculate a performance bond requirement, for each
combined commodity in a portfolio, SPAN will: sum the scan risk
charges, any intra-commodity spread and spot charge; apply the
offsets for all inter-commodity spread credits within the
portfolio; compare the above sum with any existing short option
minimum requirement, and determine the greater of the two compared
as the risk of the combined commodity.
[0057] The total margin requirement for a portfolio evaluated with
the SPAN system is the sum of all combined commodities less all
credit for risk offsets between the different combined commodities.
United States Patent Application Pub. No. US 2006/0059607 A1,
incorporated herein by reference, describes the specific algorithms
and methodologies used in a SPAN-based performance bond system.
[0058] SPAN Deficiencies:
[0059] The current SPAN-based margin system has certain
disadvantages when applied to modern exchange product slates
available at many exchanges. The SPAN system was not intended to
act as a risk management system for the complex, over-lapping
product slates offered on many exchange trading floors and
electronic trading systems. Indeed, there is a growing need to
increase cross margining efficiencies between the exchange floor
and the exchanges electronic trading system. Because of these
certain deficiencies it is possible that the exchange clearing
organization could be under-margined, facing risk beyond its
operating parameters. In other situations, because of the
deficiencies of SPAN to handle modern trading products, the
clearing organization could be over-margined.
[0060] SPAN is limited in its ability to analyze the risk position
for trading contracts with both inter-commodity and inter-calendar
spreads. For example, assume a trader took a long position in both
July Light Crude Oil (CLN) and August Brent Crude Oil (CSQ).
Concurrently, the same trader took a short position in August Light
Crude Oil (CLQ) and September Brent Crude Oil (CSU). Present SPAN
methodology would spread CLN and CLQ together and also CSQ and CSU
together, resulting in two inter-month spreads. The actual risk,
however, entails both inter-month and inter-commodity spreads.
While this particular long and short position may be accommodated
by split allocation, those skilled in the art will appreciate that
other more complex relationships would not be accommodated, for
example, a situation in which a trader takes a long position
January Heating Oil (HOF) and February Heating Oil (HOG) while at
the same time taking a short position in March RBOB Gasoline (RBH)
and April RBOB Gasoline (RBJ). SPAN methodology would create
inter-month spreads but no inter-commodity spreads. What is needed
is a comprehensive margin system that would spread each month of
each commodity against every month of every commodity.
[0061] The ever increasing number of exotic options and trading
products further illustrate the inefficiencies of the present
SPAN-based margin system used in the industry. For example, the
SPAN system currently uses the split allocation method for calendar
spread and crack spread options on a delta basis. This approach
effectively utilizes a delta-based margin system from the pre-SPAN
era. Average price options are even more cumbersome and are
considered by SPAN to be a different commodity than their
associated more traditional options. Moreover, delta-based
margining of spread options can be inefficient and often
inaccurate.
[0062] Under SPAN, inter-commodity spread credits between
commodities do not reference individual months. The credits are
typically determined according to front month relationships (for
example, the earlier months of a spread relationship). However,
customers will get these credits regardless of which months are
spread. For example, if a front month Heating Oil futures contract
is spread against a back-month Crude Oil futures contract, the
credit still applies, although in this instance it is probably
unwarranted. A more efficient comprehensive margin system would
take into account not only which commodities are being spread, but
also which months within that commodity are being spread.
[0063] Additionally, futures contracts often have risk reduction
characteristics when margined across more than one product. For
example, Crude Oil may reduce the risk of an offsetting Heating Oil
and Unleaded Gasoline position. A comprehensive margin system
without the inter-calendar and inter-commodity limitations of a
SPAN-based margin system would allow each position to hedge against
the market risk of each other position.
[0064] VAR as a Risk Measure
[0065] Value-at-Risk (VAR) is a method for assessment of
market-based financial risk in the trading of financial instruments
which overcomes many of the limitations of the prior-art
performance bond systems. Given a trading portfolio of financial
instruments and a description of the market variance
characteristics, a VAR analysis statistically determines how much
of the value of the trading portfolio might be lost over a given
period of time with a given level of probability. This
determination is often expressed as the VAR measure. A more
complete explanation of the VAR methodology can be found in Return
to RiskMetrics: The Evolution of a Standard, RiskMetrics Group,
Inc., April 2004, incorporated herein by reference.
[0066] VAR typically measures the market, or price risk of a
portfolio of financial assets--that is, the risk that the market
value of the portfolio will decline as a result of changes in
interest rates, foreign exchange rates, equity prices, or commodity
prices. VAR models aggregate the several components of price risk
into a single quantitative measure of the potential for losses over
a specified time horizon, conveying the market risk of an entire
portfolio in one number. Moreover, VAR measures focus directly on
loss of portfolio value, one of the major reasons for assessing
risk.
[0067] Though there are many different models used in the art to
arrive at a value-at-risk measure, the common categories of models
include parametric models (including variance-covariance approaches
using equally weighted moving averages and exponentially weighted
moving averages, as well as Monte Carlo simulations for non-linear
positions) and historical simulation approaches.
[0068] VAR models typically measure market risk by determining how
much the value of a portfolio could decline over a given period of
time with a given probability as a result of changes in market
prices or rates. For example, if the given period of time is one
day and the given probability is 1 percent, the VAR measure would
be an estimate of the decline in the portfolio value that could
occur with a 1 percent probability over the next trading day. Thus,
if the VAR measure is accurate, losses greater than the VAR measure
should occur less than 1 percent of the time.
[0069] Two important components of any VAR model are the length of
time over which the market risk is to be measured and the
confidence level at which market risk is measured. The choice of
these components greatly affects the nature of the VAR model.
[0070] The time period used in the definition of value-at-risk,
often referred to as the "holding period" is discretionary. VAR
models assume that the portfolio's composition does not change over
the holding period. This assumption argues for the use of short
holding periods because the composition of active trading
portfolios is apt to change frequently. One-day holding periods are
typically used, though holding periods could be in fractional days
or hours, or multiple days, weeks, months, or years.
[0071] Value-at-risk measures are most often expressed as
percentiles corresponding to the desired confidence level. For
example, an estimate of risk at the 99 percent confidence level is
the amount of loss that a portfolio is expected to exceed only 1
percent of the time. It is also known as the 99.sup.th percentile
VAR measure because the amount is the 99.sup.th percentile of the
distribution of the potential losses of the portfolio. In practice,
value-at-risk estimates are typically calculated from the 90.sup.th
to the 99.9.sup.th percentiles, and most commonly from the
95.sup.th to the 99.sup.th percentile range.
[0072] Although many approaches may be applied when calculating
portfolio VAR models, including parametric methods, Monte Carlo,
and historical simulation methods, the use of past data is
necessary to estimate potential changes in the value of the
portfolio in the future. Using past data makes the assumption that
the future will be like or similar to the past. Different VAR
models, however, often define the past differently and make
different assumptions about how markets will behave in the
future.
[0073] Two parametric approaches to VAR modeling, the equally
weighted moving average approach and the exponentially weighted
moving average approach, are "variance-covariance" VAR models that
assume normality and serial independence with an absence of
non-linear positions such as options. Non-linear positions,
however, may be accommodated with known simulation methods, such as
Monte Carlo methods, and used in conjunction with
variance-covariance matrices of the underlying market process or
rates.
[0074] Variance-covariance approaches to VAR modeling are so named
because they can be derived from the variance-covariance matrix of
the relevant underlying market prices or rates. The
variance-covariance matrix contains information on the volatility
and correlation of all market prices or rates relevant to the
portfolio. Knowledge of the variance-covariance matrix of these
variables for a given period of time implies knowledge of the
variance or standard deviation of the portfolio over the same
period.
[0075] The dual assumption of normality and serial independence
simplifies value-at-risk calculations because all percentiles are
assumed to be known multiples of the standard deviation. Thus, the
VAR calculation requires only an estimate of the standard deviation
of the portfolio's change in value over the holding period. Also,
serial independence means that the size of a price move on one day
will not affect estimates of price moves on any other day.
Therefore, longer horizon standard deviations can be obtained by
multiplying daily horizon standard deviations by the square root of
the number of days in the longer horizon. When the assumptions of
normality and serial independence are made together, a single
calculation of the portfolio's daily horizon standard deviation may
be used to develop value-at-risk measures for any given holding
period and any given percentile.
[0076] A VAR model may be based on a variance-covariance approach
using an equally weighted moving average by calculating a given
portfolio's variance (and thus, standard deviation) using a fixed
amount of historical data. The portfolio variance is an equally
weighted moving average of squared deviations from the mean. The
fixed amount of historical data may include a relatively small
number of recent days, for example, about seven or less days, about
14, 21, 28, 35, 42, or 49 or less days, or greater than 49 days,
relying on the assumption that only very recent data is relevant to
estimating potential movements in portfolio value. Or the fixed
amount of historical data may include a large amount of data
accumulated over numerous weeks, months or years, for example about
six months or less, six months or more, one year or less, one to
five years, or greater than five years. Utilizing large amounts of
data may be preferred to estimate potential movements
accurately.
[0077] The calculation of portfolio standard deviations using an
equally weighted moving average approach is:
.sigma. t = 1 ( k - 1 ) s = t - k t - 1 ( x s - .mu. ) 2 ,
##EQU00001##
where .sigma..sub.t denotes the estimated standard deviation of the
portfolio at the beginning of day t. The parameter k specifies the
number of days included in the moving average (the "observation
period"). The parameter x.sub.s specifies the change in portfolio
value on day s. And the parameter .mu. specifies the mean change in
portfolio value, which may be assumed to be zero.
[0078] Exponentially weighted moving average approaches to
variance-covariance based VAR models emphasize recent historical
observations by using exponentially weighted moving averages of
squared deviations. In contrast to equally weighted approaches,
these approaches attach different weights to the past observations
contained in the observation period. Because the weights decline
exponentially, the most recent observations receive much more
weight than earlier observations. The formula for the portfolio
standard deviation under an exponentially weighted moving average
approach is
.sigma. t = ( 1 - .lamda. ) s = t - k t - 1 .lamda. t - s - 1 ( x s
- .mu. ) 2 . ##EQU00002##
[0079] The parameter .lamda., referred to as the "decay factor,"
determines the rate at which the weights on past observations decay
as they become more distant. In theory, for the weights to sum to
one, these approaches should use an infinitely large number of
observations k. The parameter .mu. is again preferably assumed to
be zero.
[0080] Due to the normality and serial independence assumed in
parametric approaches generally and in the variance-covariance
approaches exemplified herein, the VAR measure may be expressed as
a multiple of the standard deviation of a portfolio.
[0081] U.S. Pat. Nos. 5,819,237 and 6,085,175, herein incorporated
by reference, discuss prior-art systems for determining the VAR
measure of a portfolio. FIG. 1 depicts a data flow diagram of an
exemplary prior-art system for determining the VAR measure of an
existing trading portfolio based off of a variance-covariance
method. In such a conventional VAR system, a trading portfolio P of
financial instruments is decomposed into a series of component
asset flows or positions. This process is often referred to as
"shredding," and produces a set of positions that approximates the
current value and risk behavior of the portfolio. The positions are
then mapped onto a set of specified, benchmark positions made at
specified future time intervals from the present. The future time
intervals are typically know as "tenors" and the combination of
position type (e.g., crude oil, gold, U.S. Dollars, and the like)
and a tenor is typically termed a "vertex." The mapping is useful
in order to provide a representation of the portfolio as a
standardized collection of positions. The vertices onto which the
positions are mapped are those also used in a variance-covariance
matrix Q of the market values of the benchmark positions. The
covariance matrix Q describes the current market characteristics to
a reasonable degree of detail. The shredding and mapping creates a
set p of mapped positions from a portfolio P. These positions are
then subjected to arithmetic operations with covariance matrix Q to
produce the VAR measure.
[0082] For example, assume that the trading portfolio includes
financial instruments maturing in arbitrary number of days from the
present, such as 22 days. The covariance matrix Q typically
includes only vertices for other maturation periods of the given
financial instrument, such as at 7, 30 and 60 days from the
present. In order to reliably determine the VAR measure in a
conventional manner, the financial instrument is then mapped into
selected position vertices, for example at either 7 or 30 days, or
some distribution there between. There are a number of known
mapping and shredding functions available to create the mapped set
of positions p.
[0083] From the mapped positions, the VAR measure of the portfolio
is determined by taking the square root of the product of the
transpose p' of set of mapped asset flows p. The resulting VAR
measure specifies how much money a trader might lose in the current
trading portfolio over a given interval of time with a given
probability.
[0084] For example, a financial instrument known as a "currency
swap" may consist of the promise to pay certain amounts of
Deutschemark in return for receiving certain amount of U.S.
dollars, at certain times. Shredding reduces the currency swap into
some set of positions, being, for example, negative in sign for the
Deutschemark positions and positive in sign for the U.S. dollar
positions. These shredded positions are each scheduled to occur at
some assigned point in time in the future, as determined by the
swap contract itself. To measure the market risk of the swap, the
market risk of a benchmark set of positions is determined, for
example, for $1 received (or paid) today, in one week, in one
month, in 3 months, 6 months, 1 year, and so forth, and similarly
for 1 DM received (or paid) at the same tenors. The risks are
determined in part by the variances and covariances of all these
quantities at the selected tenors, and in part by the amounts of
such benchmark (vertex) positions. (Risks are measured only at
benchmark tenors because measuring variances and covariances for
all possible positions at all possible arbitrary tenors would be
computationally impractical.) The shredded positions, however, do
not necessarily lie exactly upon the vertices where the benchmark
risks were measured. Therefore, the shredded positions are "mapped"
onto the vertices in amounts that behave equivalently in terms of
risk.
[0085] In the currency swap example, the set of shredded asset
flows is mapped onto "equivalent-sized" asset flows lying at the
vertices. Then the risk of all mapped asset flows is calculated
together using the known VAR equation, accounting for the risk
offsets of low covariance.
[0086] Alternatively, and instead of a variance-covariance based
VAR model, there are numerous known historical simulation
approaches to VAR models. Rather than using a specific quantity of
past historical observations to calculate the portfolio's standard
deviation, historical simulation approaches use the actual
percentiles of the observation period as value-at-risk measures.
For example, for an observation period of 500 days, the 99.sup.th
percentile historical simulation value-at-risk measure is the sixth
largest loss observed in the sample of 500 outcomes (because the 1
percent of the sample that should exceed the risk measure equates
to five losses.)
[0087] In a historical simulation approach, the 95.sup.th and
99.sup.th percentile VAR measures will not be constant multiples of
each other. Moreover, value-at-risk measures for holding periods
other than one day will not be fixed multiples of the one-day
value-at-risk measures. Historical simulation approaches do not
make the assumptions of normality or serial independence. However,
relaxing these assumptions also implies that historical simulation
approaches do not easily accommodate translations between multiple
percentiles and holding periods.
[0088] Those skilled in the art will appreciate that there are
numerous alternative approaches and models to determine the VAR
value of a given portfolio, including Marginal VAR and Incremental
VAR approaches. Marginal VAR determines the amount of risk that a
particular position may add to a financial portfolio, or in another
sense, how the VAR measure of a portfolio would change if a
particular position were bought or sold. Marginal VAR can be
formally defined as the difference between the VAR measure of the
total portfolio and the VAR measure of the portfolio without the
position of interest. Incremental VAR measures the effect of buying
or selling a relatively small portion of a position within a
portfolio on the overall risk of a financial portfolio. Incremental
VAR is particularly useful when rebalancing a portfolio, such as
selling off a portion of a position without liquidating the entire
position.
[0089] VAR-Based Margining
[0090] To date VAR has not been used to establish performance bond
requirements by an exchange clearing organization. FIG. 2 is a flow
chart depicting a prior-art margining system 100 wherein the
performance bond requirement is determined using SPAN. The exchange
clearing organization 110 electronically receives the daily open
positions 112 of a particular portfolio P, then using a SPAN-based
system 114, the clearing organization 110 calculates the risk
exposure associated with the open positions and assigns a
performance bond or margin requirement 116 based on the risk
exposure. The margin requirement 116 is transmitted to a clearing
member 118 who in turn passes the margin requirement to the
clearing member's customer 120. After receiving the margin
collection 122 from its customer 120, the clearing member 118
deposits the clearing member margin deposit 124 into the clearing
member margin account 126 with the exchange in order to meet the
margin requirement 116.
[0091] In an implementation of the present invention, the
traditional SPAN-based margining process is augmented by an
additional margining system based on VAR. Referring to FIG. 3, a
clearing member makes an election or a request to include a
particular portfolio in an exchange's VAR-based margining program.
Alternatively, a clearing member's customer may elect or request to
participate in an exchange's VAR-based margining program by making
an election or requesting to include a particular portfolio of at
least one or more positions in the VAR program, either directly to
the clearing organization or through the clearing member. All open
positions for a given time period, usually the end of a particular
trading session, associated with the selected portfolio are entered
into a VAR-based margin system 160 and a SPAN-based margin system
114 in order to create a margin report 116 which includes a
VAR-based margin requirement, a SPAN-based margin requirement, and
a comparison or delta of the VAR-based margin requirement and the
SPAN-based margin requirement. In an implementation the VAR-based
margin requirement may be input as an additional variable in the
SPAN-based margin system.
[0092] The margin report may then be communicated to the clearing
member together with the associated margin requirement. Typically,
the clearing member will then pass along the margin requirement to
the clearing member's customer, collect the necessary fees, and
then deposit the margin with the clearing organization.
[0093] The ultimate margin requirement that the clearing member is
required to post may be based entirely on the SPAN-based margin
requirement. In this situation, the clearing member may use the
delta between the SPAN-based margin requirement and the VAR-based
margin requirement to lower the cash layout the clearing member may
require from its customer. For example, if SPAN creates a margin
requirement of $1000 while the VAR-based margin indicates that $200
more correctly accounts for the risk involved with a selected
portfolio, then the clearing member could charge $200 dollars to
its customer and loan the customer the remaining $800 plus interest
to cover the margin requirement. The customer benefits because it
does not have as large a cash requirement and the clearing member
profits on the interest charged while having a firm understanding
of the risk involved with the loan.
[0094] Alternatively, the clearing organization could determine the
difference between the VAR-based margin requirement and the
SPAN-based margin requirement and apply that difference in the form
of a credit or debit to the either the SPAN-based margin
requirement or the margin account associated with the selected
portfolio on deposit with the clearing organization.
[0095] FIG. 4 illustrates an exemplary implementation of the
invention and depicts a voluntary VAR-based re-margining process.
First the clearing member selects an account portfolio 201 to
participate in VAR. A position file 204 is generated indicating all
open positions associated with the elected account portfolio 201
for a designated time period. Position file 204 is input into a
SPAN calculation file 208 together with SPAN parameter files 209
and relevant real time market data 207. SPAN calculation module 208
then uses known SPAN methodologies to generate SPAN report 218 and
SPAN calculation output file 219. SPAN report 218 and SPAN
calculation output file 219 input into the clearing member download
240 which provides the clearing members a performance bond
requirement based on SPAM methodologies.
[0096] At the same time that selected position file 204 is input
into the SPAN calculation module 208, selected position file 204 is
also input into VAR calculation module 206. Current or relevant
interest rates 222, volatility inputs 223, and settlement prices
224 are input into VAR parameter generator 220, which generates VAR
variant files 225 and VAR co-variant files 226 according to known
VAR parameter methodologies.
[0097] VAR variant files 225 and VAR co-variant files 226, together
with the selected position file 204, input into VAR calculation
module 206 wherein VAR-based margin requirements are determined
using known VAR methodologies to generate VAR report 214 and VAR
calculation output file 216. VAR report 214 and VAR calculation
file 216 are input into clearing member download 240.
[0098] VAR variant files 225 and VAR co-variant files 226 are also
input into VAR parameter archiver 212, which categorizes variant
files 225 and co-variant files 226 by parameters established by the
exchange for cataloging into VAR historical database 213. VAR
variant files 225 are also input into the clearing member download
240.
[0099] By this process, the clearing member receives, in clearing
member download 240, performance bond requirements as reported in
SPAN report 218 and VAR report 214, together with the supporting
calculations for such performance bond requirements, as reported in
SPAN calculation output file 219, and VAR calculation file 216. The
clearing member is also provided with the relevant VAR variant
files 225 supporting the VAR Report 206. By providing a VAR-based
margin report in addition to the SPAN-based report, the exchange
provides valuable risk management to the clearing member, which in
turn may be offered as a service to the clearing members customers.
By way of example, assuming that SPAN creates a margin requirement
of $1000 while the VAR-based margin indicates that $200 more
correctly accounts for the risk involved with a selected portfolio,
the clearing member could charge $200 dollars to its customer and
loan the customer the remaining $800 plus interest to cover the
margin requirement. The customer benefits because it does not have
as large a cash requirement and the clearing member profits on the
interest charged while having a firm understanding of the risk
involved with the loan.
[0100] The SPAN-VAR difference may also be provided as part of the
Voluntary VAR re-margining process 200 described above. VAR report
214 and VAR calculation output file 216, together with SPAN report
218 and SPAN calculation output file 219, may also input into SPAN
VAR difference report generator 230, which compares and calculates
the variance between the two different performance bond
requirements and generates SPAN-VAR difference report 231 and
SPAN-VAR delta file 232.
[0101] SPAN-VAR difference report 231 may be included in the
clearing member download 240. SPAN-VAR delta file 232 may also be
included in the clearing member download 240 or may be input into
clearing member margin report process 235 which generates an
updated margin requirement to the clearing member through updated
margin requirement report 236. The updated margin requirement
accounts for the difference between the traditional SPAN-based
margin requirement and the alternative VAR-based margin
requirement. This difference could be applied to the clearing
member's margin requirement in the form of either a credit or a
debit to the clearing member's margin account held at the clearing
organization. Alternatively, the SPAN-VAR difference could be
applied to the outgoing margin requirement, thereby increasing or
decreasing the performance bond required by the clearing
organization.
[0102] The components described above may be implemented as one or
more computer software/logic programs/modules stored in a memory or
computer storage device and executable by a computer processor to
implement the disclosed functionality and process. It will be
appreciated that the components described above may include a
computer system and network. Such a computer system should include
a Pentium-class processor, or suitable equivalent, a hard disk
drive with sufficient capacity, a memory with sufficient capacity,
and a suitable output device such as a flat panel LCD display.
Further the computer should execute an appropriate operating
system, such as Microsoft Windows XP, published by the Microsoft
Corporation, located in Redmond, Wash. The computer system may
include a network interface being of a suitable type for the
network, such as an Ethernet or optical based network. The network
may be a public or private network, such as the Internet, an
intranet, a virtual private network, or other TCP/IP or non TCP/IP
based network, as is known in the art. Further, secure protocols,
such as sHTTP or encryption, may be included to protect
communication from being intercepted or modified and to generally
authenticate users and ensure secure operation. It will be
appreciated that any suitable computer system having suitable
processing, storage and communications capability may be used with
the disclosed embodiments, such as a mainframe computer,
mini-computer, a workstation, a personal computer or a personal
digital assistant. It will be further appreciated that the
disclosed embodiments may be executed on a single computer system
or one or more components may be executed on a computer system
which is separate from one or more computer systems executing the
remaining components, and suitably interconnected, such as via a
network.
[0103] While the disclosed embodiments relate to a computer
software program which is stored in the memory of a computer and
executed by the processor(s) of the computer to perform the
disclosed functions, it will be appreciated that one or more of the
disclosed components may be implemented in hardware or a
combination of hardware and software, and is implementation
dependent.
* * * * *