Active margin system for margin loans using cash and stock as collateral and its application in Chinese market

TL;DR

This paper proposes an active margin system using cash and stock as collateral, employing a Markov chain model to reduce margin calls and adapt to stock price changes, improving risk management in Chinese margin trading.

Contribution

It introduces a novel active margin system based on a Markov chain model that effectively reduces margin calls compared to traditional systems.

Findings

Fewer margin calls with the proposed system.

Similar average loan costs under both systems.

System adapts actively to stock price changes.

Abstract

Margin system for margin loans using cash and stock as collateral is considered in this paper, which is the line of defence for brokers against risk associated with margin trading. The conditional probability of negative return is used as risk measure, and a recursive algorithm is proposed to realize this measure under a Markov chain model. Optimal margin system is chosen from those systems which satisfy the constraint of the risk measure. The resulted margin system is able to adjust actively with respect to the changes of stock prices. The margin system required by the Shanghai Stock Exchange is compared with the proposed system, where 25,200 margin loans of 126 stocks listed on the SSE are investigated. It is found that the number of margin calls under the proposed margin system is significantly less than its counterpart under the required system for the same level of risk, and the average costs of the loans are similar under the two types of margin systems.