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FRM Part II · FRM Exam Part II · Margin (Collateral) and Settlement

A risk manager compares two initial margin models for a bilateral derivatives portfolio. Model A uses a 99% one-tailed confidence level over a 10-day horizon; Model B uses a 99% level over a 10-day horizon but is calibrated to a period of stressed market volatility. Which statement is most accurate regarding procyclicality?

Model B is less procyclical. Calibrating initial margin to a stressed period keeps requirements elevated in calm markets, so margin calls rise less when volatility spikes. A model calibrated only to current conditions, like Model A, forces larger and sudden margin increases during stress.

  1. AModel B reduces procyclicality because margin requirements change less when volatility moves between calm and turbulent periodsCorrect
  2. BModel B increases procyclicality because it always yields lower margin
  3. CModel A is less procyclical because it responds more slowly to volatility
  4. DBoth models are equally procyclical because the confidence level and horizon are the same

Explanation

Calibrating to stressed volatility keeps margin high in calm periods, so the increase in a crisis is smaller, dampening procyclical margin calls. Model A rises sharply when current volatility spikes. Model B generally yields higher, not lower, margin in calm periods.

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