The Effect of Anti-Procyclical Central Counterparty Margins On Trading

Abstract

The last decade has seen substantial research and debates on the procyclicality of Central Counterparty (CCP) margins, but these are limited to the sensitivity of margin models to market conditions. This paper establishes the effect of feedback loop between the sensitivity of margin models and trading behavior. It utilizes unique design and high-frequency data from Indian markets to conduct an event study surrounding the revisions in the margin models to enhance their anti-procyclicality (APC) characteristics. The analysis shows that current period volatility influences position exits in the subsequent period and vice-versa. The analysis further shows that for the same price movement, position exits are lowered under stronger APC margin. The effect is weaker for participants having variation losses, where limiting losses may be an additional incentive to exit positions in addition to rise in initial margins. The findings support the argument that better APC characteristics of CCP margins can attenuate volatility.