MVA: How to Forecast Initial Margin for Client Trades and Dynamic Hedges

From the perspective of trading economics, initial margin (IM) requirements are impactful, owing to the associated funding costs. This is the role of Margin Valuation Adjustment (MVA), which represents the cost of funding IM requirements over the life of a trade, or over the life of a portfolio.

Up until now the focus of MVA has been primarily on the client trade. However, from a bank perspective, servicing clients can require posting IM for client trades, and for their hedges. Thus, IM should be forecasted for both and reflected in MVA.

On Wednesday, December 5th at 10:00am EST, Numerix Director of Quantitative Research, Andrew McClelland, Ph.D., identified how IM requirements arise from client trades and the hedge trades they necessitate, with the aim of accurately determining the total MVA impact of the trade to the bank.

Dr. McClelland addressed:

  • Basic definitions and background for CCR, VM, MPoR (Margin Period of Risk), IM and MVA Valuation Adjustment
  • Structure of an MVA calculation and forecasting sensitivities for IM
  • IM for dynamic hedges: forecasting hedge ratios and hedge-side IM
  • Worked example for a Bermudan hedged by vanilla swaps and swaptions
  • When, and how much, hedge-side IM to charge on to clients
  • Key Takeaways

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