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FRM Part II · FRM Exam Part II · Central Clearing

During a sharp market sell-off, a CCP's risk model recalibrates and raises initial margin requirements on all members within days, forcing liquidity strains. Which feature of the margin methodology most directly explains this outcome, and what is the usual mitigation?

The cause is procyclicality of margin models, where requirements calibrated to recent volatility jump during stress and drain liquidity. Regulators and CCPs mitigate it with anti-procyclicality tools such as stressed-period floors, longer lookback windows, or margin buffers built up in calm markets.

  1. AProcyclicality of margin models; mitigated by anti-procyclicality tools such as stressed-period floors or margin buffersCorrect
  2. BWrong-way risk in the default fund; mitigated by raising variation margin frequency
  3. CNetting set fragmentation; mitigated by bilateral rather than cleared trading
  4. DConcentration of the default waterfall; mitigated by removing initial margin

Explanation

Margin models calibrated to recent volatility raise requirements in stress, draining liquidity when it is scarcest; this is procyclicality. Tools such as stressed lookback floors or buffers that build in calm periods dampen the swings. The other options misidentify the mechanism or propose unrelated remedies.

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