MARGINING COMPONENT OF THE STOCK MARKET CRASH OF OCTOBER 2008 - A Lesson of the Struggle with Combinatorial Complexity

Dmytro Matsypura, Vadim G. Timkovsky

Abstract

In July 2005 the US stock market started using the risk-based approach to margining customer accounts gradually excluding from margining practice the strategy-based approach, which has been used for more than four decades. In this paper we argue that this change has a direct link to the stock market crash of October 2008. We also show that among the main reasons of this change are high strategy-based margin requirements in comparison with much lower risk-based, the combinatorial complexity of the strategy-based approach, and the failure of the brokerage industry to adopt the achievements of combinatorial optimization.

References

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  14. 3. The U.S. Security and Exchange Commission.
  15. 4. Prime offsets have minimum position quantities.
  16. 5. Component quantities of prime offsets are integers, unlike the quantities of convertible securities with noninteger conversion ratios.
  17. 6. The upper index ? denotes the transposition.
  18. 7. BBI: Broad Based Index.
  19. 8. ETF: Exchange Traded Fund.
  20. 9. NBI: Narrow Based Index.
  21. 10. These percentages follow Rule 15c3-1a(b)(1)(i)(B).
  22. 11. These gains and losses are called “theoretical gains and losses” in SEC Release 34-53577.
  23. 12. For example, if s is a position in a call option, then, after calculating iv = max{cv - e, 0}, i.e., its in-the-money amount for valuation point cv, and its estimated market price pv corresponding to cv, its outcome can be calculated as max{iv, pv} - p, where p is the purchased price of the call option, multiplied by the option contract size.
  24. 13. The model must be approved by the DEA (Designated Examining Authority). By February 2008, only the OCC model implemented in STANS was approved, see Federal Register, Vol 73. No. 29, February 12, 2008.
  25. 14. This remark does not refer to the literature devoted to studying the relationship between margin requirements and market volatility; see a survey in (Kupiec, 1998).
  26. 15. The Options Clearing Corporation.
  27. 16. SEC Release 34-27394, October 26, 1989.
  28. 17. Theoretical Intermarket Margining System.
  29. 18. SEC Releases 34-38248, February 6, 1997.
  30. 19. The SEC published the related NYSE proposal for public comments in SEC Releases 34-46576, October 1, 2002 and 34-50885, December 20, 2004, before approving the approach in July 2005.
  31. 20. www.cboe.com/margin, CBOE Rules 12.4, 9.15(c), 13.5 and 15.8A.
  32. 21. SEC Releases 34-46576, October 1, 2002, and 34-50885, December 20, 2004.
  33. 22. SEC Release 34-52031, July 14, 2005.
  34. 23. SEC Release 34-54125, July 11, 2006.
  35. 24. SEC Release 34-54918.
  36. 25. Exchange Act Release No. 58251, July 30, 2008, 73 FR 45506, August 5, 2008.
  37. 26. Gross Domestic Product.
  38. 27. See, for example, The Wall Street Journal, July-August 2007, for numerous reports on margin calls and associated forced sales.
  39. 28. From the speech of William McC. Martin, Jr., Chairman of the Board of Governors of the Federal Reserve System from April 2, 1951, through January 31, 1970, at the hearing on the study of the stock market before the U.S. Senate Committee on Banking and Currency on Monday, March 14, 1955.
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Paper Citation


in Harvard Style

Matsypura D. and G. Timkovsky V. (2012). MARGINING COMPONENT OF THE STOCK MARKET CRASH OF OCTOBER 2008 - A Lesson of the Struggle with Combinatorial Complexity . In Proceedings of the 1st International Conference on Operations Research and Enterprise Systems - Volume 1: ICORES, ISBN 978-989-8425-97-3, pages 484-489. DOI: 10.5220/0003841504840489


in Bibtex Style

@conference{icores12,
author={Dmytro Matsypura and Vadim G. Timkovsky},
title={MARGINING COMPONENT OF THE STOCK MARKET CRASH OF OCTOBER 2008 - A Lesson of the Struggle with Combinatorial Complexity},
booktitle={Proceedings of the 1st International Conference on Operations Research and Enterprise Systems - Volume 1: ICORES,},
year={2012},
pages={484-489},
publisher={SciTePress},
organization={INSTICC},
doi={10.5220/0003841504840489},
isbn={978-989-8425-97-3},
}


in EndNote Style

TY - CONF
JO - Proceedings of the 1st International Conference on Operations Research and Enterprise Systems - Volume 1: ICORES,
TI - MARGINING COMPONENT OF THE STOCK MARKET CRASH OF OCTOBER 2008 - A Lesson of the Struggle with Combinatorial Complexity
SN - 978-989-8425-97-3
AU - Matsypura D.
AU - G. Timkovsky V.
PY - 2012
SP - 484
EP - 489
DO - 10.5220/0003841504840489