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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.

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    $\begingroup$ Why would IM be constant for the life of a trade ? The schedule-based IM from the WGMR has a charge which is based on the remaining life of the trade. So the charge will change over time. If you use a model-based approach like the ISDA SIMM then the IM will change every day. $\endgroup$ – Dom Oct 20 '16 at 14:25
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    $\begingroup$ Note also that IM is not calculated at individual trade level. It is calculated across all nettable trades between 2 counterparties. $\endgroup$ – dm63 Dec 9 '16 at 11:16
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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.

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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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