What is the margin period of risk, and how does it affect collateral haircuts and exposure calculations?

The margin period of risk (MPOR) is the assumed time interval between a counterparty's last variation margin payment and the complete liquidation or replacement of the portfolio following a default. It directly scales the potential future exposure (PFE) component and determines how large collateral haircuts must be.\n\nWhy MPOR Matters:\n\nDuring the MPOR, market prices can move adversely while no new margin is received. A longer MPOR means more potential exposure, requiring:\n- Higher PFE in capital calculations\n- Larger haircuts on collateral (collateral values can also deteriorate)\n- More conservative initial margin requirements\n\nRegulatory MPOR Assumptions:\n\n| Context | MPOR | Rationale |\n|---|---|---|\n| Bilateral OTC (< 5,000 trades) | 10 business days | Standard closeout period |\n| Bilateral OTC (>= 5,000 trades) | 20 business days | Complex portfolios take longer to unwind |\n| Centrally cleared | 5 business days | CCP has standardized closeout procedures |\n| Disputed margin (bilateral) | 20 business days | Disputes delay margin collection |\n| Illiquid trades (bilateral) | 20 business days | Hard-to-replace positions extend closeout |\n\nHaircut Scaling:\n\nCollateral haircuts scale with the square root of the MPOR. If the base haircut for a 10-day MPOR is H_10, the adjusted haircut for a different MPOR is:\n\nH_MPOR = H_10 x sqrt(MPOR / 10)\n\nWorked Example:\nRedwood Capital holds $50 million in investment-grade corporate bonds as collateral against a bilateral derivative portfolio. The base 10-day haircut for IG corporates is 6%.\n\nScenario A -- Standard bilateral (MPOR = 10 days):\nHaircut = 6% x sqrt(10/10) = 6.00%\nUsable collateral: $50M x (1 - 0.06) = $47.0 million\n\nScenario B -- Large portfolio (MPOR = 20 days):\nHaircut = 6% x sqrt(20/10) = 6% x 1.4142 = 8.49%\nUsable collateral: $50M x (1 - 0.0849) = $45.755 million\n\nScenario C -- Cleared through CCP (MPOR = 5 days):\nHaircut = 6% x sqrt(5/10) = 6% x 0.7071 = 4.24%\nUsable collateral: $50M x (1 - 0.0424) = $47.88 million\n\nImpact on Capital:\nThe difference between Scenario A and B reduces effective collateral by $1.245 million. For a bank with thousands of netting sets, this aggregates into materially higher capital requirements.\n\nKey Exam Points:\n- MPOR is a floor, not an estimate -- actual closeout may be faster or slower\n- During the 2008 crisis, some Lehman portfolios took months to unwind, far exceeding any assumed MPOR\n- The 5,000-trade threshold for the 20-day MPOR incentivizes portfolio compression\n- Wrong-way risk (counterparty default correlated with adverse market moves) makes MPOR assumptions more critical\n\nPractice MPOR calculations in our FRM Part II question bank.