When variation margin attacks: Difference between revisions

At about the same time computer-based trading began to revolutionising the financial markets and the madcap spirit of 1980s free-love ''laissez-faire'' delivered their radical deregulation. It is not unreasonable to suppose these conditions contributed to an explosion in the market for OTC swaps during the 1980s.<ref>These three forces combined to create a mammoth. [http://faculty.citadel.edu/silver/IF/MBA_course/Chap9_Swap_Evolution.pdf Citadel] estimates USD interest rate swaps volumes went from from zero in 1981 to over half a billion dollars by 1987. </ref>

It did not take long for folks to realise that these new swap things presented a whole new class of risks.<ref name="fwmd"/> Swaps provide unfunded exposure to assets — you don’t have to put down any cash up front — and if you trade in any great frequency, your total notional can quickly blow out of all proportion, especially given the typical notional size of individual swap transactions, which was in the millions of dollars. The market hit upon two neat tricks to manage these risks: [[netting]] and [[credit support]].

Now, even having applied set-off and netting, either side of a swap contract could still be left with a large, volatile exposure. The exposure could move by hundred of millions of dollars in a single day, and could flip in or out-of-the-money quite suddenly.

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