An Active Margin System and its Application in Chinese Margin Lending Market

TL;DR

This paper introduces an active margin system for Chinese margin lending that uses a Markov chain model to measure risk and optimize margin ratios, enhancing risk control for brokers in volatile markets.

Contribution

It proposes a recursive algorithm to calculate negative return probability and develops an operational margin system tailored for Chinese stock markets.

Findings

The method effectively controls risk in margin lending.

Application to Shanghai Stock Exchange data demonstrates practical utility.

The system adapts margin ratios based on market conditions.

Abstract

In order to protect brokers from customer defaults in a volatile market, an active margin system is proposed for the transactions of margin lending in China. The probability of negative return under the condition that collaterals are liquidated in a falling market is used to measure the risk associated with margin loans, and a recursive algorithm is proposed to calculate this probability under a Markov chain model. The optimal maintenance margin ratio can be given under the constraint of the proposed risk measurement for a specified amount of initial margin. An example of such a margin system is constructed and applied to $26,800$ margin loans of 134 stocks traded on the Shanghai Stock Exchange. The empirical results indicate that the proposed method is an operational method for brokers to set margin system with a clearly specified target of risk control.