Why Initial Margin Valuation Adjustment Requires Simulation
Summary
The document explains why initial margin valuation adjustment (MVA) requires simulation even though initial margin is calculated at the start of a trade. It clarifies that initial margin is recalculated over time: market conditions, portfolio positions, and cash flows can change the risk measure used to set the required margin. A margin estimate such as a ten-day value-at-risk therefore changes as the valuation date advances.
To estimate future funding costs, Monte Carlo paths are used to project portfolio states and recalculate initial margin at future dates along each path. Those projected margin requirements form an initial-margin profile, which can then be combined with funding assumptions to estimate MVA. The document also distinguishes initial margin, which covers potential close-out risk, from variation margin, which responds to mark-to-market exposure. It gives a conceptual explanation but no numerical example or detail on the choice of margin model, funding rate, collateral treatment, or implementation conventions.
Key ideas
- Initial margin changes over time as market conditions, portfolio composition, and cash flows change.
- A starting-date margin estimate cannot determine future funding needs on its own.
- Monte Carlo simulations project future states and allow initial margin to be recalculated along each path.
- The resulting margin profile supports an estimate of the funding cost called MVA.
- Initial margin covers close-out risk, while variation margin covers mark-to-market exposure.
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Full text
# MVA, initial margin valuation adjustment for derivatives # MVA, initial margin valuation adjustment for derivatives I have read a number articles about margin valuation adjustment (MVA), which effectively is the funding cost of the initial margin, which has become important because of the rise of central clearing and because new rules on bilateral OTC derivatives requiring IM and VM. - IM should be static for the life of an individual trade, however manner its is calculated initially (e.g., 10 day VAR), right? - Why is there a need to conduct a simulation exercise to calculate the funding cost of this IM if it's known? I get CVA and FVA because they are based on future MTM's, which are simulated to give an estimated exposure or funding requirement, not clear on MVA. ## Answer by user25205 (score 7) https://quant.stackexchange.com/a/30924 The name initial margin is somewhat misleading as initial margin is dynamic i.e it is adjusted through time. So, as you say, on day zero, it can be computed as a 10 day VaR VaR(10, t0). But, on day one, the market conditions will have changed, or you may have paid a cashflow etc etc..... so your 10 day VaR will also change (i.e. VaR(10, t1) is not equal to VaR(10, t0)), hence your initial margin will change. So, given a set of Monte-Carlo paths (the simulation you were mentioning), on every path you should try and estimate the 10 day VaR starting from a given date. This will enable you to build your initial margin profile and from there you can compute the cost of funding this IM i.e. the so-called MVA. ## Answer by DKK (score 2) https://quant.stackexchange.com/a/39813 Unlike VM which covers MtMs , IM covers close-out risk (2 weeks portfolio volatility)., it is dynamic , and required for major OTC users (see BCBS IOSCO 2015 ) i.e top up segregated account if need be so to cover portfolio volatility risk. When the IM profile is available MVA can be calculated, this could be the cost of borrowing cash/securities so to post them as IM ( or benefit from receiving IM collateral ) HTH
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