Determining margin for futures contracts: the role of private interests and the relevance of excess volatility
This article examines the relation between
volatility and margin levels in order to assess
the plausibility of the Excess Volatility Argument
and the Prudential Exchange Hypothesis.
The next section discusses the private interests
involved in setting margin levels and their
relevance to the justification of the Prudential
Exchange Hypothesis. The Excess Volatility
Argument is critiqued in the following section.
Analysis of the theory underlying the Excess
Volatility Argument, a review of existing evidence
on the links between margin and volatility,
and new tests of the theory all fail to support
the proposition that raising margins leads to
reductions in volatility. Evidence for the Prudential
Exchange Hypothesis is mixed. Tests
relating margin changes to previous levels of
volatility fail to confirm the hypothesis. A
cross-sectional approach to test this hypothesis
is introduced and some preliminary results are
reported. Conclusions concerning the Prudential
Hypothesis and the Excess Volatility Argument
are summarized in the last section of the
article.