Excessive Margin Requirements and Intermarket Derivative Exchange Competition: A Study of the Effect of Risk Management on Market Microstructure




Dutt, Hans R.

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The S&P 500 Index futures contract is traded on the Chicago Mercantile Exchange that is regulated by the Commodity Futures Trading Commission. The S&P 500 Index options contract is traded on the Chicago Board of Options Exchange that is regulated by the Securities and Exchange Commission. The differing regulatory structures have led to the S&P 500 Index futures and options contracts being subject to differing customer margining (collateral) requirements. Generally, S&P 500 Index options customer margin requirements are higher than their futures counterpart for a comparably leveraged position. This dissertation examines whether higher relative margin costs lead to trader substitution between markets such that margin costs help determine relative market share. The empirical result I find is that margin costs do not appear to affect market share between options and futures markets. This result may not necessarily be a rejection of economic theory that suggests traders will substitute between like assets based on differences in these assets’ costs, but may result from large illiquidity in options markets as characterized by the empirical finding of relatively large bid ask spreads in options markets for similarly leveraged positions. The finding of relatively large bid ask spread costs in the S&P 500 options market is consistent with the academic literature finding that price discovery occurs primarily in the futures market ( Fleming, Ostdiek and Whaley (1996)).



Derivatives Markets, Margin Requirements, Risk Management, Market Microstructure, Futures Markets, Options Markets